Can a Second Home Be Considered a Primary Residence?

Your primary residence is where you live full-time. This is the address you have on your driver’s license and other forms of identification and financial documents. Your primary residence is different from your second home, vacation home, and any rental properties you own. 

The Internal Revenue Service (IRS) only allows filers to have one primary residence – and most mortgage lenders follow suit. However, you can reclassify your primary residence if you are making real estate changes. There are both tax and mortgage advantages to moving forward with a reclassification. 

This guide will dive into the IRS guidelines for residence classification and go through the process of changing what you consider your primary residence. While the answer to, “Can a second home be considered a primary residence,” is no, you may have more flexibility in defining your residency than you think. 

IRS Guidelines for Primary Residence Classification

The IRS has several guidelines to identify primary residences specifically to prevent people from claiming vacation homes and additional properties as their main living spaces when it becomes convenient.

Without these guidelines, tax deductions and other exemptions would run rampant with countless Americans committing tax fraud. Here are a few rules that are used to prove residency. 

The Two Out of Five Year Rule

The homeowner must live in the property for at least two out of the last five years. This means they need to spend 730 days at the residence. The 730 days do not have to be consecutive.

The goal of this law is to ensure that homeowners spend ample time at the property and aren’t claiming that a vacation home that is only visited a few times each year is claimed as a primary house.     

Proof of Residency Requirements

The IRS accepts a variety of documents from homeowners to prove residency. These include voter registration cards, employment documents, vehicle registration, and school registration for kids. Homeowners can also use documents like utility bills to prove residency.

Most people only have one residence where they send important information. Even if they move across different houses, they can only choose one address for their driver’s license and employee file. This is considered the filer’s primary residence. 

Restrictions on Claiming the Primary Residence Tax Exclusion

One of the main reasons why the IRS asks filers to define their primary residence is for tax exemption purposes. Homeowners can claim a $250,000 tax exemption ($500,000 for couples filing jointly) on capital gains once every two years.

This is a substantial tax deduction for some homeowners who choose to sell their properties. By asking the homeowner to define their primary residence, the IRS confirms that the filer isn’t selling a vacation home and passing it off as their main house.

This guide will dive deeper into capital gains tax benefits later.

Example Scenarios of Reclassifying a Second Home

Tax jargon can be tricky, especially if you are reading guidelines directly from the IRS website. The following scenarios highlight how vacation properties can turn into primary residences through the natural moves of the people who live there. 

• Scenario 1: A homeowner moves into a vacation home full-time and sells the previous primary residence. They can enjoy the tax benefits of selling a primary residence where they lived the previous two years while defining a new primary residence in their vacation home. 
• Scenario 2: A landlord converts an investment property into a primary residence to take advantage of tax savings. After their tenants move out, the owner moves in for two years before selling the property. 
• Scenario 3: A couple nearing retirement moves into a second home, intending to claim it as their primary residence for capital gains exclusion benefits. They live in the home for two years before selling it, then add the profits to their retirement savings. 

Each of these scenarios highlights how it takes time to define a primary residence. Even if you move into a property full-time, you will need to live there for at least 730 days before you can reap the capital gains tax exemptions.

Benefits of Converting a Second Home to a Primary Residence

There are several reasons why a homeowner would want to define a primary residence that is different from their current one. The financial benefits that come with your primary residence aren’t usually extended to your second home.

This is why owners need to carefully consider what they consider their main house. 

Capital Gains Tax Exclusion

People who sell their primary residences are exempt from paying taxes on the first $250,000 in capital gains (or $500,000 for couples filing jointly). This is one of the main reasons why people move into investment properties for two years before selling them. While this is a valuable tax exemption, it’s important to remember how capital gains taxes work. 

• Capital gains are the profits from the sale. If you bought a house for $225,000 and sold it for $425,000 then your capital gains are $200,000. This puts you below the $250,000 threshold.  
• The exemption taxes profits after the $250,000 mark. As another example, if you bought a house for $225,000 and sold it for $500,000 then your profit would be $275,000. After the exemption, you would only be taxed on the remaining $25,000. 
• You can deduct improvements and marketing fees, along with closing costs and Realtor commissions from your capital gains. Using the same example, a homeowner who sells their property for $500,000 might pay $30,000 in commission (six percent), bringing them back under the capital gains threshold. 

If you are considering selling a rental property, calculate what you would pay in capital gains when it’s time to file your taxes. It might not be worth the cost of moving into the house for two years.

Lower Mortgage Rates or Refinancing Options

Lenders typically offer lower interest rates for primary residences compared to second homes. If you need to refinance one of your investment properties, you may benefit from living there as a primary residence if you can last until the two-year mark.

The long-term savings could be worth it.

Homestead Exemptions Reducing Property Taxes

Some states offer homestead exemptions on primary residences that lower property taxes or provide creditor protection. Research different homestead exemptions where your investment properties are located and see if you could benefit from moving into one and classifying it as a primary residence. Know that even if a homestead exemption is favorable in one area, the property taxes and other costs (like utility usage) could still be higher in the long run.

Challenges and Limitations of Reclassifying a Second Home

While many people focus on the benefits of reclassifying a rental property as a primary home, there are significant limitations that might be more frustrating or costly than you realize.

Here are a few limitations to keep in mind before you start packing your bags and completing change of address forms.

Timing Constraints

Two years is a significant part of your life. Even if you spread the 730-day requirement across five years, you will still need to wait before you can turn a rental property into a primary residence. Make sure you are ready to disrupt your life by living in the rental home or have the ability to spend enough time there each year. 

Mortgage Restrictions

If the second home has an existing mortgage as an investment or vacation property, you may need to seek lender approval before you can refinance it as a primary residence. You might not get the mortgage interest rates you want during the refinance process and it could take longer than you like. 

Refinancing could also affect what you pay in taxes each year. What you save through a lower interest rate could be lost due to higher taxes. 

Read your mortgage documents before you move forward with your moving plans. See how both your primary residence and investment property would be affected.

Capital Gains from Prior Property Sales

If a homeowner already used the capital gains tax exclusion within the past two years, they may need to wait before reclassifying the second home to benefit. If your whole purpose of this process is saving money on capital gains taxes, make sure the math works out.

Other costs could eliminate any potential savings. This is particularly true if you need to pay moving costs to bring your belongings from one house to the next or will lose rental income while one house sits vacant – even temporarily.

State and Local Requirements

Some regions have additional legal and tax requirements for declaring a property as a primary residence. You may benefit from meeting with local tax experts and real estate agents where your investment property is. They will have a deeper understanding of the costs and benefits of changing your primary residence to a property in the area.

Regardless of whether your investment property is down the street or in a different state, make sure you have a team of experts on your side.

How to Reclassify a Second Home as Your Primary Residence

If you decide to move forward with reclassifying your personal residence, there are a few important steps to take. This will ensure that all the paperwork is in place so your property taxes are accurate and any documents are sent to the right place. 

Notify Your Lender

Homeowners should inform their lender if they are changing their occupancy status to ensure compliance with loan terms. This is particularly important if you are moving out of your primary residence while still paying a mortgage on it.

Some lenders do not allow borrowers to turn their homes into rental properties. Moving out shortly after you buy a house, especially without notifying your lender, could be viewed as a form of occupancy fraud. Your lender may view the mortgage as void and foreclose on your house. 

Life happens. You may have bought a house and then fallen in love, causing you to move out to be with them while keeping the property. Talking to your lender and discussing your options is still important for protecting yourself. 

Update Address Records

Once you have a new primary property, you will want to create a paper trail highlighting how it is your main residence. Start changing your mailing address, voter registration, driver’s license, and tax documents to reflect the new residence.

These documents can also create a timeline for when you switched your residency. If you registered to vote and submitted your tax return in April, that’s when you can prove you lived in your new place.

File Your Homestead Exemption

Check with your local tax authority to apply for homestead exemptions or other tax deductions. While many people focus on the federal benefits of claiming a rental property as a primary home, there are also state and local taxes to consider. Make sure you have a big-picture view of your finances throughout this entire process.

Decide Whether You Want to Reclassify Your Primary Residence

If you are done owning a second home and want to reap the maximum tax deductions when selling it, you may consider classifying it as a personal residence. However, this can be a time-consuming challenge that usurps other parts of your life. Your kids may need to go to another school and your work schedule could change – even if you clock in remotely. 

Before you make a big change, read the IRS rules and mortgage requirements carefully. Know what you are getting into and how much you would actually save in the long run. Look beyond your tax return and consider all of the costs associated with the move, including the lack of rental income during this time. 

If you are still unsure about this change, consult with a real estate agent and tax advisor to ensure you meet all legal and financial obligations. Your agent might have other options that can help you manage your different properties. 

To find a Realtor, use FastExpert. You can meet with agents who specialize in investment properties. They will understand the tax implications and opportunities that come with owning a second home. Try FastExpert today and move into the future with confidence.