What’s the Difference Between a Second Home and an Investment Property?

It’s not uncommon for people to use the terms “second home” and “investment property” interchangeably when talking about a residence they rent out for part of the year. However, for tax and legal purposes, the two types of properties are significantly different. This is especially true if you are seeking to perform a 1031 exchange to defer capital gains taxes on the sale of a property.

In this guide, we’ll briefly discuss what defines second homes and investment properties and go over a few key differences to consider.

What Is a Second Home?

A second home is a property that you purchase in addition to your primary residence, primarily for personal use rather than for generating rental income. These homes are often located in vacation destinations or areas where the owner spends part of the year (such as a beach town, mountain resort, or rural retreat). Unlike investment properties, second homes are intended for the owner’s enjoyment, not as income-producing assets.

To qualify as a second home in the eyes of lenders and the IRS, the property generally must be occupied by the owner for a portion of the year and not rented out full-time. Occasional short-term rentals may be allowed, but heavy rental activity could reclassify the property as an investment. Financing a second home often comes with more favorable mortgage terms compared to investment properties, including lower interest rates and down payment requirements.

When considering a second home, it’s important to understand how it fits into your lifestyle and financial goals. Tax benefits, loan terms, and long-term obligations differ significantly from those of an investment property.

What Is an Investment Property?

An investment property is real estate purchased with the primary goal of generating income or profit, whether through renting it out, reselling it at a higher value, or both. Unlike a second home, investment properties are not typically used by the owner for personal stays and are instead treated as business assets.

These properties come with unique financial and tax considerations, often requiring buyers to meet stricter lending criteria due to the added risk to lenders.

These properties are usually subject to higher mortgage rates, but are often eligible for tax deductions on business-related expenses such as:

Mortgage interest
Property taxes
Repairs and maintenance
Depreciation
Property management fees

Because of these distinctions, it's important to clearly define your intentions before purchase. Misclassifying a property can lead to complications with lenders and with the IRS.

Second Home vs. Investment Property: Key Differences

Take a look at the information below to see some of the essential distinctions between investment properties and secondary homes.

Primary Purpose

Second Home: Personal use
Investment Property: Income generation

Owner Occupancy

Second Home: Must be occupied by owner at least 14 days per year
Investment Property: Must be occupied by owner fewer than 14 days per year

Rental Activity

Second Home: Limited short-term rental allowed
Investment Property: Long-term or short-term rentals allowed

Financing Requirements

Second Home: Lower down payment and interest rates
Investment Property: Higher down payment and interest rates

Tax Treatment

Second Home: Limited deductions (including mortgage interest); some personal use allowed
Investment Property: More deductions (mortgage interest, depreciation, etc.)

Location Flexibility

Second Home: Must be more than 50 miles from primary residence
Investment Property: Can be within 50 miles of primary residence

Loan Qualification

Second Home: Based on personal income
Investment Property: Based on rental income + personal income

IRS Classification

Second Home: Personal residence (with occasional rental)
Investment Property: Business/income property

How Mortgage Requirements Vary Between Second Homes and Investment Properties

Mortgage requirements can differ significantly between second homes and investment properties, mainly due to the risk profile lenders associate with each type. Understanding these differences is crucial before applying for a loan, as they affect everything from interest rates to qualification standards.

For second homes, lenders generally offer more favorable terms because the property is seen as a personal residence. However, you must be able to prove that you'll use the home personally and not rent it out full-time.

For investment properties, lenders see more risk because repayment often depends on rental income. As a result, loan terms are more restrictive and expensive.

Key Mortgage Characteristics for Second Homes

Lower down payment requirements (typically 10% to 20%)
Interest rates similar to or slightly above primary residence rates
Must be suitable for year-round occupancy
Borrower must live in the home for part of the year

Key Mortgage Characteristics for Investment Properties

Higher down payment requirements (usually 15% to 25% or more)
Higher interest rates compared to second homes
Stricter credit score and debt-to-income ratio requirements
Rental income may be used to help qualify for the loan
May require cash reserves to cover several months of mortgage payments

Second Homes vs. Investment Properties: Why It Matters for 1031 Exchanges

When it comes to deferring capital gains taxes through a 1031 exchange, the distinction between an investment property and a second home is more than just semantics. It determines whether you qualify for this powerful tax benefit at all.

A 1031 exchange allows you to sell one investment or business-use property and reinvest the proceeds into another like-kind investment property, without immediately paying capital gains tax. However, the IRS enforces strict rules about what types of properties qualify.

Why Investment Properties Are Eligible

To qualify for a 1031 exchange, a property must be:

Held for investment or business purposes
Exchanged for another like-kind investment property
Owned for a sufficient period
Some cite an unoffical “two-year” rule that says owning a property for at least two years is sufficient to show that the property is an investment property and not a “flip.”

Common examples of eligible properties include:

Single-family rentals
Multi-family units
Commercial buildings
Vacant land held for investment

Because investment properties are intended to generate income or appreciate in value over time, they fit squarely within the IRS’s definition of exchange-eligible real estate.

Why Second Homes Are Not Eligible

In contrast, second homes do not qualify for 1031 exchanges because they are considered personal-use properties, not investments. Even if you rent the home occasionally, the IRS generally does not consider it an investment unless it meets specific, narrowly defined criteria.

Special Exception: Safe Harbor Rule for Vacation Rentals

There is a limited exception if a second home is truly used as a rental property. Under the safe harbor guidelines for vacation homes, the property may qualify for a 1031 exchange if:

It is rented at fair market value for at least 14 days per year for two consecutive years before the sale.
The owner's personal use is limited to the greater of 14 days or 10% of the rental days per year.
After the exchange, the replacement property meets the same criteria.

Even under these conditions, the IRS will closely scrutinize whether the property is truly an investment and not merely a disguised second home if there is any personal use.

Start a 1031 Exchange to Defer Capital Gains Tax

If you have an investment property you’re ready to sell and replace with one or more properties of equal value, a 1031 exchange can be a great option. It helps you by deferring taxes on the capital gains you receive from the sale of the relinquished property, allowing you to diversify your portfolio and build a winning real estate investment strategy.

Ready to start the process? Open an order with First American Exchange Company today.