Tips Before Buying a Vacation Home Investment Property

Before Buying, Ask Yourself a Few Questions First

Buying a vacation home is not something you should just jump into. There are several questions you should ask yourself before you even begin to look for a potential property in order to make sure you are able to accomplish all that you want.

1. Do I Know How Much This Will Cost?

Lenders will look at a vacation home purely as a luxury item, and you should too. Their second home mortgage rates will typically be higher than those for your primary residence because of the belief that you will make payments on your first home in times of financial crisis rather than your vacation home. As such, you’re more likely to default on a vacation home, making it a higher risk for them. First, consider the overall purchase price of the house you’re looking for. Are you able to afford the 20% second home mortgage down payment on the home plus the 3% of closing costs that will be due at the time of signing? If not – or if it’s tighter than you’re comfortable with – you may consider holding off on your second property purchase until you have other expenses taken care of, such as retirement or college savings. Not only will you need to consider the overall price of your vacation home investment, but you should also factor in the maintenance costs of it as well. Since you’re not on site (most likely), you won’t be able to monitor the small issues that primary homeowners typically notice quickly, which can lead to bigger issues down the road. A good rule of thumb is to set aside about 1% of the home maintenance costs every year to help cover problems like a hot water heater exploding or furnace maintenance. You should also consider building this into the eventual price of the security deposit as well.

2. Why Do I Want to Buy Second Home in the First Place?

What is your purpose in owning a second home? Are you looking for a property that you can use with just your family to spend holidays with, or are you looking at it as an investment property that you expect to rent or sell in the future? Understanding the purpose behind your vacation home investment will help you in your search for the perfect property. Admittedly, this process is much easier if you’re buying an investment property for personal use. You can look at properties where you want, buy what you want, decorate (or don’t) however you want, and make it your own in every way imaginable. Buying a second property is substantially harder if you want to use it as an investment property since you’ll have to take tenant tastes into consideration. A secluded beach-front property may be ideal for where you want to spend your time, but if it involves 30 miles of backroads to get there, your renters may look for something that’s more accessible. You also won’t be able to expect the same amount of return on an investment property as you would on a personal property. A house requires a substantial amount of upkeep; for the same price, you could travel frequently and stay in hotels, so unless you see yourself returning often, it may be better to use it as a rental home.

3. Will I Need to Hire Help?

It’s not uncommon for people to make a vacation home investment under the belief that they’ll be able to do all the work themselves, but once they find out exactly just how much work goes into finding renters, advertising the home, making small repairs, and just general maintenance, they quickly change their tune. Whether you live close by or are 100% hands off on the upkeep of your house, you’ll have to decide if you need to use a property management service (or just general handyman) to maintain the property and take care of the day-to-day operations. If so, you can expect to pay between 20-30% of your rental income on property management services alone. It may seem steep, but that’s a small price to pay for peace of mind, plus it allows you to scale multiple properties if you choose to do so.

4. Do I Need to Decide Today?

The beauty of a vacation home investment is that it’s generally a token of luxury, meaning if you have the money to afford one, you don’t have to rush to buy the first home that comes on the market. You have the flexibility to wait for a good opportunity and buy the home that you can reasonably afford. This will also help you buy a home that is right for your needs. Many would-be second-home-owners are appalled to find out after a hasty purchase that their residence is on a 100-year floodplain, or is right in the middle of an earthquake-rich environment. These types of issues are not hard to find, but you have to do a little digging first. Regardless, there’s no reason to rush into a purchase unless you’re 100% certain as to the decision.

5. What Type of Property Do I Want?

Not every vacation house needs to be a “home” per se; in many cases, you may be better off with a condominium or even a rental unit on your existing property. If you have an apartment or condo unit, you may be able to even deduct some of the cost of maintenance with your fees to the local association, so that’s something to consider as well. Not everything needs to be a house by the lake; a house that is close to where your kids are going to college may be perfect as a getaway spot and potential vacation spot for others.

1. Deduct Instead of Itemize

Not everyone itemizes their taxes, but enough people do that nearly $77 billion of mortgage interest was claimed on taxes in 2016, representing about nearly 30% of all individual taxpayers. Tax reform enacted at the beginning of 2018, however, has nearly doubled the standard deduction for people who want to claim mortgage interest, which should discourage people from itemizing altogether. Depending on how high your income is, it may make sense to take advantage of the deduction instead of itemizing.

2. Steer Clear of High-Priced Homes

This is relative to your location, but one of the changes in tax law this year caps the mortgage interest deduction at $750,000, instead of the $1 million that it previously sat at. If you’re looking at a home that is less than about $900,000, you probably won’t notice the difference, but once you start looking at vacation homes that are more expensive, be aware that you won’t be able to claim all of it on your taxes. One bright spot in the new tax laws is that capital gains taxes weren’t affected, so if you have lived in your house for two of the five years previous to selling it, you can keep up to $250,000 from the profits if you file separately, or $500,000 by filing jointly.

3. Not Everything is Deductible Anymore

Unfortunately, one of the bigger new laws in effect regards strictly vacation home purchases. If you want to buy second home strictly as a vacation house, you won’t be able to deduct the mortgage interest on it at all, meaning you’ll have to take that into effect when you do your taxes next year (this only applies for new home purchases, so it doesn’t affect a vacation home you already own). Also, you won’t be able to deduct a home equity loan either, whereas previously, you were able to deduct up to $100,000 from your taxes if you took a loan out. Property taxes are also capped. The normal deduction allowed for homeowners to deduct all of their property taxes no matter the amount, but 2018 tax law limits that deduction to $10,000. This will primarily affect high-value homes in places like New York or California, but since roughly 4.1 million people pay property taxes greater than $10,000, it will have a wide-reaching effect as well.

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Is Buying a Vacation Home Possible?

If you’re in the market to buy second home, there are certainly ways to do so, whether that means tapping into the equity on your primary residence to come up with the down payment for a second house or renting out the vacation home at times to recoup some of the cost. If you want to refinance your second home in order to get a lower interest rate, there are ways to do that as well. Regardless, owning a vacation home does not have to be something that’s reserved for millionaires. Anyone can own a second property if they’re willing to do the research and be patient for the right opportunity.

What About the Tax Advantages?

For as long as there have been taxes, people have been looking for breaks, and many of those throughout history have come in the form of real estate. As a matter of fact, it’s a long-held belief by many that real estate has some of the best tax advantages of any investment opportunity on the market.

For starters, nearly everything that you spend on your house can be deducted from your taxes for the following year. Interest, taxes, insurance, certain expenses, losses and even depreciation all help reduce your tax bill and can sometimes result in a substantial amount of savings. Furthermore, once you sell the rental property, you can roll the proceeds into a new house without having to pay any capital gains taxes as well.

That doesn’t mean that buying a vacation property – especially since 2018 – doesn’t come without some risk. Since the beginning of the new year, there has been a substantial amount of reform regarding housing tax law that you should be aware of.

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