Getting a house? It’s crucial to know what kind you’re purchasing.
Your taxes and the interest rate you pay on your mortgage may be impacted by how the classification of the home you buy is done. Your new property may fall under one of three categories: principal dwelling, secondary residence, or investment property.
When purchasing a home, it’s crucial to understand the distinctions between these three. You could wind up saving or losing a lot of money depending on how your new property is categorized.
Define primary residence
Your house is your principal residence, usually referred to as a primary residence. Your primary residence, whether it be a house, condo, or townhome, could be eligible for a lower mortgage rate if you can demonstrate that you occupy it for the majority of the year.
You might also be able to deduct mortgage payments from your income tax as well as exclude earnings from capital gains tax when you sell your principal house. The IRS established some specific guidelines to assist you in determining if your house qualifies as a primary residence because of the tax advantages.
The Primary Residence Rules
Your primary residence will be considered to be the only house you own and occupy. But the IRS assesses your principal residence if you reside in more than one house using the following criteria:
- Where you often spend your time
- Your registered address as it appears on your driver’s license, voter registration card, tax returns, and USPS documents
- The residence close to your place of employment or banking, the recreational facilities to which you belong, or the residences of your relatives
These are straightforward criteria, but if a homeowner owns many residences, things might become more challenging.
Definition Of Primary Residence For Mortgage
The sort of residential property you’re financing when you apply for a mortgage—primary residence, second residence, or investment property—will affect the mortgage rate you obtain. Mortgage rates are often lower for primary residences.
Over the course of the loan, a reduced mortgage rate can result in significant savings on interest costs. It’s critical to let your lender know if you’re requesting a mortgage for your primary residence so they can provide you with the suitable rate for the type of property. The mortgage on your principal residence can be refinanced under the same conditions. Make sure to speak with your lender before deciding on the type of refinance you want to apply for so you can get the right advice on the choice that will best suit your circumstances.
Up to a certain amount, you may be able to deduct the interest you pay on a mortgage for your principal dwelling and any additional homes you own. As of 2018, taxpayers are now permitted to write off up to $750,000 of mortgage interest on a residence. You must use Schedule A of Form 1040 to itemize your deductions in order to deduct mortgage interest.
It’s essential to comprehend everything in order to have a positive experience when buying or refinancing a home and to make sure that your mortgage has a suitable interest rate associated to it.
Gains From Your Primary Residence
In addition to receiving a tax reduction for the mortgage interest you paid, owning a primary house has other advantages. When you sell your house, you might be able to exclude capital gains as well.
When you sell an asset whose value has increased, you must pay capital gains tax. You may be able to deduct some of the capital gains from the sale profits when you decide to sell your primary house and it has improved in value. The IRS now permits taxpayers to exclude up to $500,000 in capital gains when filing jointly with a spouse or $250,000 when filing alone.
Let’s say you spend $20,000 on a house. It serves as both your primary abode and your only property. You make the decision to relocate and sell it for more money a few years later. Your profit after deducting sale-related expenses is $50,000. You won’t have to pay capital gains taxes on that profit if you qualify for the exceptions. Depending on your income, the capital gains tax rate ranges from 0% to 15% to 20%.
For the exclusion to apply,
- Out of the preceding five years, you had to have owned your house for at least 24 months.
- You must have spent at least 24 months out of the past 5 years living there as your principal residence.
- In the previous two years, you couldn’t have used another capital gains exclusion.
The capital gains exclusion is subject to a limitation that pertains to real estate that was previously acquired through a 1031 exchange. If you decide to sell one investment property and buy another, you can postpone paying capital gains tax by completing a like-kind exchange (also known as a 1031 exchange).
In a 1031 exchange, you sell one investment property and buy another investment property of like sort within a set time frame.
But what if you ultimately decide to make that investment property your primary residence? then intend to sell it? If you sell the property you bought through a 1031 exchange within five years of buying it, it won’t qualify for the capital gains exclusion.
FAQs about primary residence
Is renting out your primary property an option?
Even if you buy a house with the goal of living in it full-time, things might change, and you may find that you end up wishing to rent it out. You must speak with your mortgage lender if you want to turn it into a rental property. To be sure you can afford the enterprise, it’s also a good idea to educate yourself on the tax repercussions of renting out your primary house.
Is it possible to classify a second property as a principal residence?
The terms “primary residence” and “second home” refer to different types of real estate. A property cannot be your primary residence if it is legally considered to be your second home. You must spend the majority of your time in your primary house.
Can you have two mortgages on your principal residence?
You are not permitted to own two principal houses. The IRS requires you to declare one property as your principal residence for filing taxes, even if you split your time evenly between two locations or between locations while relocating for work.
It’s a good idea to know what kind of home you’re buying before making a purchase. A primary residence, also known as a principle residence, a secondary residence, or an investment property is what you intend to purchase?
The sort of mortgage rate you may be eligible for, the tax treatment of your mortgage interest payments, and any gain you realize when you decide to sell will all depend on these crucial factors. Whether you’re buying a new house or refinancing your present one, it’s crucial to know which of your properties would be deemed your principal residence.