Property taxes are applied differently to a primary residence and rental property. The government only allows you you have one primary residence at a time and considers a property a primary residence based on your occupancy of 730 days over a five-year window but not necessarily consecutively. Understanding the benefits of each and their respective restrictions and conditions will help you determine which is the best suited purchase for your situation.
Tax Benefits on Home Improvements
On your rental property you can deduct expenses and depreciation to offset the income tax on your property entirely. Expenses that can be deducted include interest on your mortgage payments, advertising and broker fees to rent out the property, repairs, cleaning costs, utilities and insurance. On your primary residence, however, the tax benefit is only the deduction of interest on your mortgage payments. Repairs or improvements cannot be deducted, though home improvements increase the home's value.
Tax Breaks on Sale of Property
If you have lived in your primary residence for at least two years in the last five years and are selling it, you can receive a government tax break of up to $500,000 in tax-free capital gains as a married couple and $250,000 if you are single. If the home is not your principal residence or you have lived in your primary residence for less than two years, you would be taxed at the long-term capital gain rate when you sell it. Even if you have been renting out your primary residence for up to two years, you are still eligible for the tax breaks.
Taxes on Capital Gains
On a rental property, you are only allowed to declare losses to the extent of gains or income of under $150,000 to a maximum special allowance of $25,000. If your income is more than $150,000, your losses are carried forward until the property is sold or your income drops below the $150,000 barrier. The downside is that on a rental property sale, if your capital gains are tax-free, you will be taxed on the depreciated amount. This could make a rental property less appealing from a tax perspective than a primary residence.
Qualified Residence Interest
If your primary residence is being rented, under the Internal Revenue Code Sec. 469j7 you may deduct the mortgage interest but only to the extent of the investment income. This mortgage interest is known as qualified rental interest. Take note that a rental that lasts for more than two years may indicate that the property is not your primary residence; since you cannot have more than one primary home at any time, you may not qualify for qualified residence interest under the law.