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To Buy or not to Buy a Second Home?

To Buy or not to Buy a Second Home?

| October 18, 2017
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Today, is second home ownership part of the American Dream? And, is it a good financial decision? The number one reason for purchasing a second home is to use it for vacationing and family retreats. Close second is an investment opportunity that would generate rental income. And many people chose to combine these two reasons and invest in a vacation home that can be rented out for the rest of the time. As real estate prices continue to climb, let’s explore why people chose to purchase a second home and what you should consider before doing so.

Those who intend to use their vacation home part of the year and rent it for the rest of the time, may benefit from tax strategies associated with this type of ownership.   If you rent your vacation home for 14 days or less the rental income is yours to keep, tax free.  If you rent your vacation home for more than two weeks and sometimes use it as a personal residence, then your deductible rental expenses may be limited. You are also entitled to deduct certain expenses which include mortgage interest, property taxes, casualty losses, maintenance utilities, insurance and depreciation. These expenses may reduce the amount of rental income that’s taxed.

The purchase of a vacation home may also be for an investment opportunity which can produce monthly rental income and future price appreciation. As an investment property there are tax rules for vacation home rental income and expenses you need to consider. You may be able to deduct most expenses mentioned above.  These decisions all have tax consequences that you will want to explore in detail with a tax professional.

Many individuals argue that the cost of hotels or staying at B&B’s may be cheaper then owning a vacation home. The acquisition of a vacation home sometimes may be a goal-based driven decision as oppose to an investment-based decision. Whatever your motivation you may want to consider the following:

  • Are your financials in good order?
    • Are you able to take on a second mortgage? Examine your maximum mortgage amount you can afford by calculating your debt-to- income ratio. This is the percentage of your monthly gross income (before taxes) that is used to pay your housing costs. These costs include all mortgages, principal, interest, taxes, insurance, mortgage insurance (when applicable), homeowners’ association fees (when applicable) and your monthly consumer debt (i.e. car payments, credit card debt, installment loans, and similar related expenses). A common guideline for debt-to- income ratio is 33% if your do not have any consumer debt and 38% including consumer debt.
    • Are you saving enough for retirement? Success in retirement savings is about managing spending and savings behavior. If we assume you earn $100,000 a year (according to the National Association of Realtors the median annual income level of second home buyers is $98,000), you are age 42 and have a retirement rate of savings of 14% or more since age 30, you are on track to replace 70/80% of your current income at retirement, have college savings for your children, have additional saving for a down payment of 20% or more and 6 months or more of emergency funds (including the additional mortgage and other expenses of the vacation home) then you may be in a position to purchase a vacation home.
  • Acquiring a second home has all of the costs of your first home with often more expenses.
  • Will you want to return to the same place year after year?
  • Consult your financial advisor and reassess your financial feasibility and goals. A financial advisor can help organize your financial goals, assets, manage your savings and investment strategies.
  • Speak to your tax professional for tax planning in the purchase of a second home.

Once you know your financial feasibility and important tax consequences you can expect, then you are ready to start thinking about buying a vacation home. These first steps are critical and may assist you in thinking about the types of properties you will consider and its location.

Where to buy your vacation home?

According to the National Association of Realtors (NAR), vacation homes popular destinations in 2016 were beaches, lakefront and the country. These properties were a median of 200 miles from the owner’s principal residence. When vacation homes are too far from the owner’s primary residence cost of airfare or gas to travel may become challenging and cause these homes to become neglected. You will need to rely on personal preferences, motives and market research. Take these factors into consideration:

  • Travel cost and time
  • Strength of the local economy
  • House resale and appreciation value trends
  • Renting is a good first step to become familiar with the area.
  • Consider operating costs: property tax, property insurance, utilities, homeowners’ association dues (if applicable), property maintenance and management
  • Quality of nearby medical care facilities
  • Will you partially rent or use the property as an investment?

Once your goal to purchase a vacation home is clear it comes down to research and scouting for the right property and location.

Is buying a vacation home right for you?

If owning a vacation home is part of your American Dream, two homes may be a great plan. The number one component of the American Dream for baby boomers, Gen Xers and Millennials is retiring comfortably, followed by raising a family and a successful career. According to NAR, vacations home show astonishing growth and “…also reflect long-term growth in the numbers of baby boomers moving closer to retirement and buying second homes to convert into their primary home in a few years.” Your vacation home can be a reward for years of hard work and a legacy that is handed down for future generations to enjoy. Planning is the key to your financial goals and consulting a financial adviser for additional guidance on life changing events may assist in making your dreams come true.


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