Owning a second home in the mountains or on the beach can be a wonderful experience. However, in most cases, it can be more of a liability rather than an asset. An asset is something you own that creates cash flow for you. In the case of a vacation home, especially if you leave it vacant so you can use it any time, it is more of a liability. In most vacation settings, it is usually possible to place a home in a rental program, which creates income to offset expenses. Initially, likely the income won’t cover all your expenses, thereby making it more of a liability than a true asset. The good news is that over time, most resort properties do accrue value. The rise in value will help accelerate the velocity of real estate wealth over time.
If you are thinking of purchasing a vacation home, here are a few things to consider as you’re making your decision.
Goals for the home
Families need to ask themselves many questions as they dive into considering the purchase of a vacation home. Goals can be immediate, such as the number of days of personal use. Or whether or not the property is going to become a legacy family vacation property to be handed down to the next generation.
Here are a few questions to help you decide.
Is rental income needed to financially support the purchase of a vacation property?
Even if someone pays cash for a vacation home there will still be several expenses. Those expenses include taxes, insurance, maintenance and landscaping, property management and homeowners association fees. With a mortgage on top of that, most people will need to rent out the property for some income to cover these expenses, especially in the early years of ownership.
If need to rent, do I manage it or hire a professional manager?
Some people choose to rent out their vacation properties by themselves by relying on a variety of online websites. If you want to do this, you will need to investigate local municipalities and homeowners association rules on short-term rentals because there can be many types of restrictions, occupancy limits, fines for violations — and even prohibition. If you want to rent and manage the property yourself, you will need to assess your ability to market your property, clean it after every guest stay, repair and maintain it, especially if your property is located outside of driving distance—or see if there are companies available to hire it out.
In most resort areas, professional vacation property managers are available. They can market your property and put it into a rental pool. This enables you to keep your property rented on a short-term basis from a distance and with no personal involvement. These managers can guide you on pricing and tell you the average number of nights per year you might expect to rent out your property. You can pick the days that you would like to schedule for personal use. For example, you might have to decide if you want to use the home yourself over the holidays or rent it out during the holidays for premium rates and maximum returns.
Should I rent the vacation home long-term?
To have a vacation home for the future, some families have bought a home and immediately leased it to a long-term tenant, say for a year or more. This is because a long-term tenant right now will help pay for the current expenses of owning it. Then later down the road, say in 10 years, you can stop renting it out and use it for yourself as a vacation home, or maybe even as your retirement home.
If it is treated as an investment, are there any tax benefits or ramifications?
As with any investment, it is a good idea to discuss with your tax advisor if they are any tax issues to consider. 2018 has brought about key changes in tax reform. Be sure to ask how those changes might affect your vacation home purchase.
A few questions might be:
- Can I deduct the mortgage interest?
- Can I take depreciation?
- If it is an investment, is there a limit on the number of personal days I can use it for?
- What expenses of running the property can I deduct?
- If it’s a rental, and I want to depreciate it, what is the maximum number of days it can be used personally?
- House trading possibilities?
Vacation homeowners will often buy a property for the possibility to use as “currency” to trade for other places to vacation. This helps keep lodging costs down at the places you might like to vacation in. Swap homes with your friends and networks — or check out various websites that enable you to trade homes in destinations across the world.
Is financing different for a vacation home?
Most 1- to 4-unit mortgage lenders can help you finance a vacation home. They will typically qualify you under normal underwriting guidelines. However, it is usually a good idea to use a lender that is familiar with vacation properties.
Can I buy a vacation home with my IRA?
I get asked this question a lot. Yes, you can buy a vacation home with funds from your IRA. You just can’t use it personally. You also need to set up a self-directed IRA account. So why would you want to do that? Let’s say you live in Boulder and eventually want to retire in Summit County. You can buy that condo in Summit County with your IRA, and rent it out full-time as an investment for your IRA. Then when it comes time to move in, you need to disburse it from your IRA, pay any applicable taxes, and you can use it personally. There are a lot more details you need to consider here. In future articles, I will cover investing in real estate using your IRA.
Exit strategy or succession planning?
The idea of having a vacation home can be very exciting, nevertheless, some planning needs to be done with regard to selling the property when the family is done with it — or figuring out how to keep the property in the family. If a couple owns a vacation home and they have 4 kids, when the couple passes away, suddenly the property has 4 owners. Those kids will have their own children and in just 3 generations there could be 10 to 20 owners. With 10 to 20 owners, you can imagine there can be many different opinions as to what to do with the property. Some of the new owners may view the ownership more as a burden than a benefit. Taking some time to create a succession plan is worth the time and effort. Generally, it is a good idea to find an attorney with experience in creating succession plans for vacation homes. They will listen to the family’s needs and goals and create a plan that works.
There are many details to evaluate when buying a vacation property. As you examine the idea of purchasing a vacation home, I recommend that you pull together a team that includes a mortgage loan officer, tax accountant, financial planner, property manager, insurance agent, Realtor – and possibly an estate planning lawyer – to consult with.
By Duane Duggan. Duane graduated with a business degree and a major in real estate from the University of Colorado in 1978. He has been a Realtor® in Boulder since that time. He joined RE/MAX of Boulder in 1982 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded two of the highest honors bestowed by RE/MAX International: The Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail [email protected], call 303.441.5611 or visit boulderco.com.