How to Buy a Second Home by Renting Out Your First: Strategy, Taxes & Risks
How to Buy a Second Home by Renting Out Your First: Strategy, Taxes & Risks
Owning two properties — using your current home as a rental and acquiring a second one — is a powerful wealth-building strategy. But it’s not risk-free. You’ll need strong financial groundwork, a clear tax plan, and realistic expectations. Read on to learn how to do this right, not regretfully.
1. Why It Makes Sense (and When It Doesn’t)
Pros
- Generates passive income from your first home
- Helps offset mortgage costs
- Enables diversification of real estate holdings
Cons & Risks
- Higher financing costs (investment property loans)
- More management burden (tenant issues, maintenance)
- Possible tax traps and cash flow shortfalls
Interest rates on investment-property mortgages tend to run 0.5% to 0.75% higher than primary residence rates.
(Source: The Mortgage Reports)
Lenders often require down payments of 20–25% for investment properties.
(Source: Baselane)
2. Financing Strategy
You’ll need to disclose that your first home will become a rental.
Expect stricter credit requirements and larger down payments.
(Source: The Mortgage Reports)Some lenders will allow you to count a portion of your projected rental income in your loan application, especially if you have a lease agreement in place.
(Source: Newcastle Loans)Maintain a strong debt-to-income ratio — lenders still prefer it under ~43%.
(Source: Radius Group)
3. Tax Rules, Deductions & Reporting
Rental Income vs. Expenses
You must report rental income and can deduct “ordinary and necessary” expenses: mortgage interest, property taxes, utilities, insurance, repairs, depreciation, etc.
(Source: IRS)
Depreciation & Passive Loss Limitations
You can depreciate the property over 27.5 years for residential real estate. However, losses may be limited by passive activity rules — if your AGI is under ~$100,000 and you actively manage, you may deduct up to $25,000 of losses.
(Source: TurboTenant)
Mixed Use Rules
If you live in the home part of the year, you must prorate deductions.
(Source: IRS Topic 415)
Sale of a property used partly as rental may disqualify you from full capital gains exclusion.
(Source: IRS Publication 527)
4. Operational & Legal Considerations
- Set up business-style bookkeeping and separate accounts for rental operations.
- Screen tenants legally, use solid lease agreements, understand eviction law.
- Budget reserves for vacancies, repairs, and maintenance.
- Determine whether to place the property in an LLC or keep it in your name.
5. A Sample Step-by-Step Plan
- Evaluate your finances (credit score, reserves, income)
- Estimate rental income and expenses to verify positive cash flow
- Shop lenders and compare terms for investment loans
- Get the lease in place for your first home to establish rental history
- Purchase your second home with favorable terms
- Manage both properties, optimize taxes, review after 1–2 years
6. Why This Strategy Fails (And How to Avoid It)
- Underestimating repairs or vacancies
- Ignoring tax complexity and penalties
- Overleveraging yourself with too high debt
- Failing to plan exit strategy (sell, convert back, or keep long-term)
Final Thoughts
At Lionhood Financial Coaching, we help people craft real estate strategies that protect their cash flow, optimize tax outcomes, and limit risk. If you're thinking about turning your current home into a rental and buying another, don’t go it alone.
👉 Schedule a coaching session today and build a resilient property plan.