Summer has arrived, and for many families, that means leaving for a few weeks. While enjoying the beautiful surroundings, warm sunshine or cultural enrichment, it is easy to imagine how nice it would be to own a home that will allow you to do it whenever you want.
But don't let your imagination run away with you. Before you shoot a beach house or mountain cottage, consider buying the same thought as buying your primary home.
The first question is whether you can afford a vacation home. Did you cover the cost of education for your children? Is your pension secure? Is your emergency fund solid? Do not take away the essentials to cover a second home, no matter how much its potential benefits. Even if you buy the property directly, you may not be able to access the capital for a while.
Second home costs more than you can imagine. In addition to the purchase price, you will need to consider maintenance, security or guardian, utilities, property taxes, furniture, travel expenses and other things. You may also need to pay association or assessment fees. And if you are planning to rent your property, you will probably need to pay for the advertising and possibly for the property manager.
Furthermore, insurance can be a major expense. Second-home property insurance often costs more than a primary residence, and can be harder to obtain. The more homes available, the bigger you can usually expect from a premium. Insurers also want you to pay more if you plan to rent a property. In areas where floods or hurricanes are possible, flood insurance generally must be added separately.
When considering how to finance a home, keep in mind that other mortgages are usually more expensive than primary mortgages, as banks tend to believe that they take on more risk. Lenders may look at the applicant's income rather than general assets, which may make it difficult for retirees or those approaching retirement to approve. Some buyers consider taking out a home equity loan for their primary residences to finance other homes, but this poses a risk to your primary home.
When deciding whether a holiday home is a practical purchase, evaluate all those costs to get an idea of the cost of the property. If you plan to maintain the property mainly for personal use, divide the cost by the number of days you plan to visit, so you can see if renting a house or staying at a hotel will be more financially acceptable.
Some consider a holiday home a car that brings in money or use it for personal enjoyment and profit. However, calculating rental income on net profit after expenses may not always be realistic. In high demand locations such as ski resorts or desirable beaches, your chances are a little better, especially if your property is only a three-hour drive from the larger city center. But the fact remains that while 25 percent of vacation home owners say they plan to rent their second home, only 15 percent do. Those who profit thus form an even smaller group.
Perhaps the most important financial consideration is the tax consequences of another home. The primary factor affecting your personal tax situation for a holiday home is the intended use of the property. Will your second home be used only by you, your friends and your family? Is it convenient to rent it to others looking for a place to rest? The specific tax rules for renting a holiday home can help you decide.
First you need to determine if your holiday home is considered a residence or rental property. The Internal Revenue Service considers your second home a residence if you personally use it either 14 days a year or more than 10 percent of the number of days you rent a home, whichever is greater. Your use, related use, or use of an unrelated party that rents below fair value are all considered "personal use" in determining the nature of the property.
If your holiday home is considered a residence, certain deductible rental costs may be limited. Renting property that the IRS considers to be a residence does not qualify as a "passive activity" for income tax purposes. This is important because the loss arising from one passive activity can be used to offset the profit gained from another. Since renting another residence is not a passive activity, you cannot use any rental costs that exceed rental income to offset income from other sources.
If the IRS considers your vacation home to be a residence and you rent a home for at least 15 days in a given year, you must characterize the division between lease use and private use. You must report all rental income in gross income with an accurate allocation of expenses between personal and rental use. Certain expenses, such as mortgages and property taxes, are usually fully deductible no matter how they are characterized, but are reported in different ways – to offset rental income if they are rental costs or as deductible deductions if personal.
Other expenses, including maintenance, insurance, depreciation, and other expenses associated with renting a holiday home are only used to offset the rental income when they can be classified as rental costs. (For a complete list of deductible expenses, see IRS Publication 527, “Rental Housing Rental.”) Allocation for lease use determines the amount of your expenses used to offset rental income. If you rent a house for half a year, then half of the cost can be deducted from rental income. Given the complications of this division, it is probably wise to involve a tax professional if you intend to use your property for personal and large rental activities.
If you do not want the burden of allocating costs and constantly seeking renters, consider the more favorable tax treatment the IRS offers for short-term rentals. The IRS allows you to rent a vacation home for less than 15 days a year without reporting any rental income in your total income, which does not require taxation. It is understandable that you cannot deduct the costs associated with renting a home, since the reimbursed rental income is not reported. In this scenario, you would list all your mortgage interest and property tax deductions on Appendix A.
If your second home will be primarily for personal use, keep in mind the rules of residence in the countries where both of your homes are located, if they are not the same. Re-establishing your place of residence can be helpful, but it can be challenging at times. New York, for example, is notorious for finding ways to keep its former residents on tax rolls. The former New Yorker may want to take advantage of Florida's preferred tax climate, but it's not just a matter of deciding.
While a timeshare may seem like a better idea on paper than buying a vacation home, the reality seems unattractive to most people. After a time lease, you pay a lump sum and a maintenance fee. An attractive time loan then guarantees you to use a specific unit at the same time each year (usually during the week, though it varies). Some newer time loans operate on a scoring system, which gives users greater flexibility in when and where they rest, but also leads to bidding for the best units at the most desirable times.
Although a time loan is initially cheaper than buying a vacation home, it does not offer the same potential or potential estimate. In fact, you just pay years in advance for vacation, not invest. In addition, maintenance fees can be increased and most deadlines do not have an expiration date. Because it is obviously difficult to sell a property, this can leave you (and potentially your heirs) indefinitely paying fees on the property you no longer want to use. It would probably be better to set aside part of your portfolio for the holidays rather than buy a time loan. This would allow your property to appreciate and avoid the risk of entering into an agreement without any easy way out.
If you decide to buy a vacation home, there are several reasons. Location is crucial. Choose the region you want to be to frequently – once a year or more – and possibly exclude other trips, depending on your time and resources. Rural areas can sometimes increase costs; for example, insurance can be more expensive if you are far from the nearest fire station. In addition, many desirable vacation facilities are at increased risk of floods or earthquakes, further increasing the potential cost of insurance. If your desired property is overseas, review that country's property laws and its history of honoring non-resident property claims.
Finally, consider the possibility of selling a holiday home someday. As soon as your use of the property declines, it is probably better to sell it to eliminate bookkeeping expenses and free up capital for other purposes. You can use the house less than you expected, or you may have used it a lot when your kids were younger, but less so now that they've come of age. Regardless, it's important to start the process as soon as you know you want to sell. The housing market is still relatively weak, so it may take longer to sell the property than you expect.
If you are renting a vacation home enough to be classified as a rental property, you would want to recover the cost of the home with depreciation. The reimbursement of expenses for residential rental property under the General Depreciation System (GDS) is 27.5 years. This capitalized expense can be used to offset rental income, thus reducing your tax bill. Depreciation deductions can cause a net loss on your rental property; But since your second home qualifies as a rental property rather than a residence, you can reduce other income from passive activities by losing it. Remember, if you visit the house on vacation, you can deduct the depreciation granted on rental days.
When it comes time to sell a vacation home, keep in mind that IRS sales will treat you differently than selling your primary home. Your vacation home does not benefit from the exclusion of capital gains of $ 250,000 ($ 500,000 if they get married, if they make a joint claim). If you have owned the property for at least 12 months, any sale proceeds will be taxed at the long-term capital gain rate.
In addition, if you have claimed depreciation on the home because of the use of rentals, you will need to rearrange the cost basis to determine the gain. Even if you have not claimed a depreciation deduction, you still need to reduce the cost of the house by the amount of depreciation you could have taken. A portion of the proceeds from the decrease in depreciation of the base is considered to be a depreciation charge and will be taxed at 25 percent.
The loss scenario occurs when a holiday home is sold; you do not receive any of the aforementioned exclusion of capital gain, nor do you obtain a tax deduction if you incur a loss on sales. For this reason, consider turning your vacation home into your primary residence before selling. If you make your second home your primary residence for two of the five years prior to the sale, you will qualify for the maximum exclusion of capital gains.
If you want to keep a holiday home in a family rather than sell it, it can cause some complications when planning your property. No matter how well your children get along, owning property can lead to disagreements and hurt feelings, as it may provide one child with a home and another property of less sentimental value. Even if your children share without problems, they can leave it to their children, which will result in the division of property between eight or 12 relatives who may or may not know or love each other very well. Those who want to keep the property may not be able to buy those who want to sell it. All in all, it can create drama you might not anticipate.
In the event that selling a home is too painful or impractical during your lifetime, you can direct your estate to sell it and split the income among your heirs. Alternatively, you can set up a trust for the operating costs of the property and then grant your heirs the right to use it under certain circumstances. Whatever you do, make your wishes explicit, and in your will, and discuss them with your children or heirs. Ideally, include a financial planner or estate planning attorney. Write everything in writing.
A vacation home can be a wonderful luxury, providing a place to escape from everyday life and build up fond memories with friends and family. As long as you consider it a purchase and not an investment, you can make an informed decision about what is good for you. If you buy a vacation home, you can approach it with realistic expectations and a good chance of enjoying the years to come.