Investment property? Primary residence? Both?

Tanya Vincent May 6, 2023

Investment property? Primary residence? Both?

Many clients come to us seeking advice on the best way to invest in real estate while accommodating their particular lifestyles. We understand! The housing market is still one of the best ways to generate wealth, whether you’re purchasing a primary home or a property purely for investment purposes. Let’s talk about how you can determine the type of home purchase that works best for you.

These are 3 primary types of home purchases we’ve identified and each of them has their own set of advantages and drawbacks. 

Primary home 

This is a home that serves as your primary residence, where you reside most of the year. The IRS typically deems a home as primary if you spend most of your time there and if it’s listed as your legal address on official paperwork (like your tax return). 

One advantage of buying a primary home is that it will have the lowest mortgage rate. Lenders typically view a primary home as less risky, since you’re unlikely to forego mortgage payments on a home that you actively live in. Additionally, most primary homeowners will have lower property taxes and can deduct the mortgage interest on their taxes. And best of all, the 2-out-of-5-years rule applies – if you live in the primary home at least 2 years out of the 5 years preceding a sale of that home, you won’t owe any capital gains tax on it. 

One way to make a primary home more affordable is to purchase a multi-unit property or a property that has a rentable ADU (additional dwelling unit). Living in one of the units would likely classify you as a primary resident, while you take advantage of the low interest rates and ability to rent out the second unit (but double check this with your lender). 

Second home 

Think of this more as a secondary or vacation home (it doesn’t have to be the second home you buy). Lenders define this as a home you spend some time in during the year, that you don’t rent out, and that must be suitable for year-round occupancy.

One advantage to a second home (other than it serving as a place to spend your vacations!) is that you can rent it out, as long as you, yourself, live in it for at least 14 days per year (but again, double check with your lender).

One disadvantage is that interest rates are generally higher on second homes for the same reason they’re lower for primary homes – you’re less likely to pay off a second home loan if you fall on hard times. And if your second home is too close to your primary home, your lender might consider it an investment property, which could mean even higher rates.

Investment property

A home that you plan to rent out or generate income from is considered an investment property. By now you should expect it – investment properties have the highest interest rates and down payment percentages, since they are not generally owner-occupied homes and come with more lender risk. 

But there are reasons why investing in real estate is so lucrative! Passive income, a wide range of tax write-offs (home improvement, depreciation, insurance, mortgage payments), and the ability to “rent” the property yourself, are all major benefits of an investment property if you plan to rent it out. Additionally, you could 1031 your investment to replace it for a better one and avoid capital gains tax. 

Other than the high rates, a few other hindrances with investment homes are the lack of liquidity, potentially difficult tenants, declining neighborhood status, and upkeep. But this doesn’t differ much from the other types of home purchases, for which you also have to consider the long term impact of location, maintenance, and future home value. 

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Now that you have an idea of the types of homes you can purchase, you may also want to consider some other key factors to help you make your decision: 

Location

It may just not be worth buying a home where you live and renting is more financially appropriate. But that doesn’t mean you can’t rent where you live and explore other areas to purchase an investment property that pays for itself. Who said you can’t be a renter and own real estate? 

Financial situation

Whether you qualify for a certain interest rate or if you have enough savings for a higher down payment will determine which investment options you go with. Maybe you find that buying a primary home is more appropriate to your financial situation, so you have time to build up equity in that home and consider an investment home in the future. 

Life stage

A newly married couple may be better suited to starting off with a primary home whereas a larger family who is renting or already owns a primary home might consider buying a smaller investment property that they can move into once their kids head off to college. Depending on where you are in life, one scenario might work better than another. 

The beauty of real estate is that it isn’t one size fits all. Finding the avenue that is the most suitable to you can result in a well-planned, advantageous investment. If you’d like to discuss your options, the Sapphire team is here for you!


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