In March 2008, my wife and I purchased a second home as an investment (think of "Flip that House" except we haven't sold it yet and if it does sell... we'll lose money).

When I originally started this process, I had read somewhere that I was not able to deduct the interest on the mortgage for this second house since it was not my primary residence.

Fast forwarding to today, I am working on my Federal taxes. The instructions for Schedule A clearly state that I can deduct interest on both my first and second home. So, it seems as if I can deduct the mortgage interest, real estate taxes, and PMI that I paid on this second home in 2008.

Please let me know if my logic is flawed... I'd rather not screw up my taxes.

Thanks!

You CANNOT deduct the PMI if you claim the house as a second home, but you CAN claim the interest and real estate taxes.

However, this is NOT a second home; it is an investment property.

If you make the house a rental property, you can start deducting the PMI, mortgage interest and real estate taxes effective on the date you make the house available to rent. You SHOULD consider this as an option, because all of the people who are losing their homes to foreclosure WILL need somewhere to live.

Until then, all of the costs you cite (PMI, mortgage interest and real estate taxes) are added to the basis to reduce your capital gain or increase your capital loss.