Your Guide to Principal Residence and Taxes
- Your principal residence (also called a primary residence) is where you live most of the time
- The IRS may also determine your principal residence based on where you receive mail, which address is on your ID or voter registration card, or which address is close to your work and activities
- Identifying your principal residence matters for your mortgage rate, capital gains tax obligation, property taxes, mortgage interest, and residency status
- Six FAQs about principal residence:
- How do I determine my principal residence?
- What if I have two homes?
- Can I rent out my home?
- What if I work in two states?
- What is a statutory resident?
- Can my vacation home be my primary residence?
- Other tips for your principal residence include ensuring you know what kind of property you’re buying, planning for taxes, and always being honest with the IRS about your property and residency status
Planning for taxes each year requires a lot of knowledge about the tax code, your assets and liabilities, IRS definitions, and state and federal laws. Some taxpayers may just have one income stream from a typical W-2 job, while others may own multiple investment properties or work as an independent contractor. Every situation is different, and they all have different tax implications.
Where you live also impacts your tax liability. Renting or owning only one home means you know where your principal place of residence is, without question. What if you own multiple properties, however? What happens if you live in more than one home or state throughout the year? These questions become common for people who invest in property, work remotely, or travel a lot.
The term “principal residence” comes into play in these situations. The IRS requires you to have one primary home where you live for tax purposes, and the designation can also impact the kind of mortgage rate you get or how much property tax you pay.
Going through the estate planning or tax planning process means you need to know where your primary residence is. This guide covers everything you need to know about principal residences and how where you live can impact your tax obligations.
What Is a Principal Residence?
Your principal residence, or primary residence, is where you primarily live throughout the year. It is your main place of residence and you live there the majority of the time. A principal residence may be a house, apartment, condo, boat, townhouse, or trailer, as long as it has a kitchen, bathroom, and sleeping space. This term is an important designation for people who own more than one residence, whether they have a vacation home or multiple rental properties.
You need to determine which of the residences you own or maintain is the place you primarily live. Just because you own a property doesn’t mean you can claim it as your principal residence. You must use the property as your home and you must either rent or own the residence. The IRS also looks at factors like these to determine which property is your principal residence:
- The place where you live most of the time
- The address you use on your ID, voter registration card, and tax returns
- Whether it is close to places where you take part in daily activities, like work, bank, or participate in local clubs and organizations
You can only have one primary residence, even if you split your time pretty equally between two properties. The IRS requires you only have one principal residence for tax purposes. It’s therefore crucial to understand what your principal residence is before diving into the tax implications.
Why a Principal Residence Matters
Determining your principal residence is important for a few reasons, including your mortgage and tax obligations. Here is a list of the main reasons why you need to carefully assess where your principal residence is:
Your lender will likely have different mortgage rates for a property based on whether it’s a primary residence, your second or vacation home, or an investment property that you’ll be renting out. Rates will typically be lower for principal residences. The same goes for rates when you’re refinancing your mortgage.
Tax-Deductible Mortgage Interest
Principal residences can have tax benefits, as well. You may be able to deduct up to $750,000 in mortgage interest for your primary and secondary residences. These deductions are based on tax-filing statuses and other factors.
Homeowner’s Exemption on Property Taxes
The housing-related perks continue with another potential tax benefit. The homeowner’s exemption varies from state to state, but you may be exempt from some property taxes based on your principal residence.
Your place of residency determines where you pay state income taxes. You will need to pay income taxes to the state where your primary residence is located, even if you own multiple properties.
Capital Gains Tax Upon Selling
You may be able to exclude capital gains when you sell your primary residence. Capital gains are how much an asset has accrued in value, and the capital gains tax applies to this additional amount. The current tax rate is 0%, 15%, or 20%, based on your income level. Individuals can deduct up to $250,000, and those who are married and filing jointly can deduct $500,000 on their income tax returns when they sell their principal place of residence. You must have:
- Owned the property for at least two years out of the last five
- Used it as your principal residence for at least two years out of the last five
- Not claimed any other capital gains exclusion in the last two years
Figuring out the principal residences of taxpayers is a key step the IRS uses to determine tax liability. You may be able to take significant tax breaks for your primary residence, but you need to know how to determine where you are domiciled. Talking to a tax expert can help you break down any confusing property ownership situation.
Six FAQs About Principal Residences
Many taxpayers only own or rent one home, so it’s straightforward which is their primary residence. When you invest in rental properties or purchase a second home, however, tax guidelines can become tricky. You need to be sure you understand where your principal residence is and how it impacts your taxes each year. These six frequently asked questions dive deeper into this issue and provide some quick facts and reminders to keep at hand:
1. How Do I Determine My Principal Place of Residence?
Your primary or principal place of residence is where you reside most of the time. It is the address where you receive mail and primarily live throughout the year. It can be any type of dwelling, like a house or apartment, that has a kitchen, bathroom, and place to sleep.
2. What if I Have Two Homes?
The IRS requires that you only have one primary residence. You can’t have two. Owning a vacation home or other type of second home still requires that you use one address as your principal location, even if you spend about equal time between them.
3. Can I Rent Out My Home?
Turning your principal residence into a rental property involves a few moving parts. You will need to work it out with your mortgage lender, since different rates may apply to this kind of property. You will also need to pay taxes on rental property income, and you will be subject to different tax rules. The use of the property must be divided between personal and rental use if you both live in the property and rent it out, and you will be able to deduct rental expenses on your tax return. The IRS states that you don’t have to report rental income or deduct expenses if you rent out a residence 14 days or fewer during the year.
4. What if I Work in Two States?
The same income can’t be taxed in two states, but you may still need to file more than one tax return. Some states have a reciprocity agreement in place, which means that workers in two different states only have to file where their principal residence is. States without reciprocity likely require you to file two returns. Sometimes you may need to file a non-resident tax return if you live in a different state than your employer. Make sure you always check the rules in your state before proceeding.
5. What Is a Statutory Resident?
You are considered a statutory resident of your state if you spend a significant part of the year in that state, even though your domicile or principal residence is in another state. You can only have one state that is your domicile. Being a statutory resident in a state means it is not where your primary residence is located. Each state has its own regulations about the number of days spent there to be considered a statutory resident.
6. Can My Vacation Home Be My Primary Residence?
You can only have one principal residence, as mentioned. It is wherever you spend the most time during the year. Sometimes your second home could become your primary residence if you spend all your time there one year, but you must have a distinct principal residence that is separate from your secondary residence.
Determining your principal residence ensures you’re able to take any tax breaks you may qualify for and can help you stay ahead of additional tax you’re subject to pay. It isn’t always easy to determine which of your properties is your primary residence, so always talk to a tax professional who can help.
Other Tips for Principal Residences and Taxes
Tax law can be very complicated. You need to know your principal residence for several purposes, and everything must be reported correctly to comply with IRS guidelines. These additional tips can help you remember what to do:
- Make sure you know what kind of home or property you’re buying before you make a purchase. Figure out if you’re purchasing a vacation home, second residence, primary residence, or investment property. This impacts the mortgage, and you’ll be able to plan for tax time sooner and more effectively.
- Learn how the type of home you own will impact your mortgage interest payments and capital gains tax, and plan for taxes in advance and with an expert so you are optimizing your liability.
- Never be dishonest with the IRS. Don’t define one property as your principal residence if it isn’t, just to take advantage of a tax break. This can lead to penalties or even charges like tax fraud.
- Ensure your home sale qualifies for exclusion of capital gains. You can only take the exclusion if the property is your main home, or principal residence. You are considered to have no gain from a home sale if you transfer a home to a spouse or ex-spouse as part of a divorce settlement.
The bottom line is to ensure your principal residence is where you live the majority of the time, even if you live in multiple properties. Make sure to discuss your unique situation with a tax attorney if you’re not sure what tax breaks you qualify for or if you have questions about the status of your residency.
Contact Silver Tax Group With Questions About Residency
Taxpayers get into complex tax territory when they invest in a second property or live and work in multiple locations. You never want to make a mistake in how you’re reporting everything on your tax return. Avoiding issues with the IRS should stay top of mind throughout the year.
Fortunately, the team at Silver Tax Group is here to help. Our experts understand the ins and outs of the law and how it impacts you. We provide consulting services when you have questions about your principal residence or taxes in general. We help clients with tax issues like audits, tax debt resolution, emergency tax services, tax fraud investigations, and much more. Reach out to Silver Tax Group to speak to a tax expert about principal residence laws and related tax implications.