You may be looking for an opportunity to purchase a vacation home, particularly if you have a spot you love to visit. The lifestyle benefits can be self-explanatory, but the financial considerations require a lot of forethought. There are several important financial pros and cons to consider when deciding whether it is time to make this commitment, and we outline these below.
What’s to Love About a Vacation Home?
- By buying a vacation home, you will always have a place to stay when you visit your favorite place, and you will not have to pay anything to stay there. Now you will not need to worry about finding a hotel room, or how much it will cost.
- A vacation property can generate income for you when you are not living there. The IRS allows you to rent out your vacation home up to 14 days each year without having to report rental income. Depending on your objectives, a vacation home can provide a steady revenue stream that diversifies your other sources of income. If you do rent out the property more than 14 days in a year, you can also deduct rental operating costs of the property such as utilities, property management fees, property taxes, mortgage interest, and home insurance premiums.
- A vacation home’s value has the potential to appreciate in the future, and therefore can be potentially a nice nest-egg booster. In contrast, money spent at a hotel or Airbnb when vacationing is a sunk cost.
- If you have your eyes on relocating in your retirement years, a vacation home can provide you with important insights about a location where you may want to retire. Years of onsite due diligence could save you big bucks down the road when you are ready to retire to your new permanent residence.
What’s Not to Like About a Vacation Home?
- There may be a greater risk of buying overvalued property if the destination is popular. In September 2020, 68% of vacation homes sold in less than a month (according to the REALTORS® Confidence Index Survey) and sales increased on average year over year by 48% in the third quarter of 2020.
- The purchase price is only part of the total cost of ownership. You also must consider your annual expenditures on real estate taxes, insurance, property maintenance, and utilities. These expenses may or may not be deductible on your tax return depending on how often you rent out the property during the year. Also remember that these are annual costs you will incur regardless of how often you or others physically stay in the property.
- There is a cost to generate that rental income. For one, after the initial 14-grace period mentioned above, the IRS considers rental income taxable. This will also change how the IRS treats the property (i.e., personal residence versus rental property) and its related expenses for tax purposes. Second, you will need to advertise to attract renters. There are also maintenance costs required to fix the property between tenants. You could also need to travel at inconvenient times to make repairs or deal with tenant issues (or hire someone to do all of it for you). Lastly, some local government agencies or home ownership associations may also restrict or charge fees for property rentals.
- There could be potential capital gains or depreciation recapture from selling a secondary investment property in the future. In contrast, there is also no tax benefit currently if you sell the home below the price that you purchased it.
There are many lifestyle appeals to owning a vacation home. Before you pull the trigger, Modera Wealth Management can help you think through the financial pros and cons for your unique situation.
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