Nearly everyone looks forward to vacations. Some of us tend to be creatures of habit, revisiting the same places again and again. Others are far more adventurous, seeking new experiences and locations.
Either way, you may have at one time or another considered buying some sort of vacation property. Maybe you love the shore and have thought about a beach home. Or perhaps you’ve considered buying a timeshare property that would allow you to trade and travel far and wide.
In this chapter we’ll look at the pros and cons of owning a second home, and help you decide whether it might make sense for you.
For you and your family, there’s nothing better than your annual three-week trip to Cape Cod, Massachusetts. You’ve rented the same cabin every summer for the past 12 years, and you know every nook and cranny of that little home away from home.
Your kids have grown up catching frogs in the pond across the lane, and some of their best friends are other kids who vacation at the same place. Sitting on the screened-in porch with a cool drink is the perfect wind-down after a long day at the beach. You treasure the time you have together there and look forward all winter to when you can pack the suitcases and head back to the cabin.
If that scenario sounds familiar, you may have considered the possibility of buying that cabin, or a similar one. That way, you could make the trip whenever you wanted to, and you’d always have the cabin to enjoy. Once your kids have families of their own, they could use the vacation home. On the other hand, how much time would you really be able to spend there? Could you get away for more than three weeks? Would you use the house on weekends, or would your kids’ activities make that impossible? Is there a possibility that you’d move to your vacation home when you retire? Would the money you’d need to buy the cabin be better spent somewhere else?
Don’t Go There
If you’re thinking of buying a vacation home, look carefully at what’s happening in the area in which the home is located. If the area is overdeveloped, overregulated, or has very low property values; the economy hits rocky times; or high inflation makes mortgage rates too high for most people to afford a mortgage, you may not be able to sell the home if you no longer want it.
Owning that cabin might be a happy dream, but you shouldn’t even consider buying a second home unless you’re sure you can afford to do so. Many people have rationalized the cost of a vacation home, and ended up losing big bucks on it.
Before you get too carried away with the thought of a little home away from home, consider the questions listed here:
Don’t Go There
Many people have lost their enthusiasm for a vacation home because they buy one that’s difficult to get to. It doesn’t take long to get really tired of working all week, driving six hours to your cabin, spending a day there and then turning around and driving six hours home.
Whether or not to buy a second property is a big decision. You’ve got to live someplace, so buying or leasing a first property is a no-brainer. When you’ve already got a perfectly fine home and are considering buying a second one, however, you’re likely to spend a lot of hours weighing the pros and cons.
Perhaps the next section, which deals with the tax advantages of a second home, will help you make your decision.
You’ve probably heard that owning a second home provides some tax relief—and, it can. There are some special tax rules and regulations that apply to second properties, however, and they can be a little confusing. Hang in there, we’ll try to make this as clear as possible.
To figure out what type of tax breaks you might get as related to your vacation home, you need to know how you’ll use the property, and how the Internal Revenue Service will categorize it.
Your vacation home will be considered a residence if you use it for personal purposes at least part of the year. If you rent it all year, it’s considered to be a rental or investment property.
The first rule to remember is that you can’t deduct the mortgage interest on your vacation home as home mortgage interest on line 10 of Schedule A if it’s not considered to be a residence. Refer to the IRS Web site at www.irs.gov/forms_pubs/forms.html to select and print a copy of Schedule A.
Vacation homes come in many packages. Your vacation home could be a house, a condo, a cabin, or a duplex. It also could be a boat or a recreational vehicle. To qualify for a tax deduction, your vacation home needs to have a bathroom, kitchen, and a place to sleep. It’s a good idea to pay a visit to your accountant before you buy a vacation home. Ask her about tax advantages for rental properties and residences, and have her run pro forma returns under different scenarios to see how your income tax return may be affected.
That doesn’t mean, however, that you can’t rent a vacation home and still have it be considered a residence. It’s all a matter of timing.
The IRS says in order to have your vacation home qualify as a residence, you need to spend at least 14 days there, or 10 percent of the amount of time that the property is rented.
Let’s say that you own a home on a lake, very close to some good ski areas. The location makes your home attractive to skiers and snowmobilers in the winter, and to families and others who enjoy the lake, hiking, and so forth in the summer. There’s a big demand for these properties, and you have no trouble renting your home for 210 days out of the year.
You might think the rental income is great, but if you don’t use the house for at least 21 days, the IRS will consider the home to be a rental property and you won’t be able to deduct your mortgage or real estate taxes entirely on Schedule A. Part of the mortgage interest will need to be declared against the rental income on Schedule E of your tax return. Refer to the IRS Web site at www.irs.gov/forms_pubs/forms.html to select and print a copy of Schedule E.
On the other hand, if you own a vacation home and rent it for less than two weeks, you get a tax break because you don’t need to report the rental income on your tax return. All that rental income is, essentially, tax free.
If your property is considered a residence, but you rent it for more than two weeks a year, you’ll need to report the rental income. You’ll also be able to take advantage of some allowable tax deductions, but since it’s a vacation home, you can’t have more expenses than income. You can come out to zero, but the IRS doesn’t permit you to take a tax loss on a vacation home.
The income and deductions offset each other when you rent a vacation home for more than two weeks. Deductions include the following:
The trick is, rental deductions, on a vacation home, can’t exceed gross rental income, less interest, taxes, and costs to advertise the property. If you rent out your beach home for 12 weeks, for instance, at $1,000 a week, your rental income will be $12,000, less the interest, taxes, and advertising costs.
If all the deductions listed earlier total more than the $12,000 of rental income received, you won’t be able to list the loss (the excess expenses) on your income tax return.
If you use your vacation home as a rental property, the system changes. First of all, you can’t use the home for more than 14 days or 10 percent of the time that it’s rented. The second difference is that passive loss rules kick in on rental property. Passive loss is when you lose money from a passive activity, such as renting property or participating in a limited partnership.
If you lose money on your rentals—that is, if the expenses you can deduct are greater than the income from your rental property, the loss can be offset by passive income. You can claim up to $25,000 of losses in a year from vacation home rentals if your income is less than $100,000. If your income exceeds $100,000, the allowable loss decreases until income reaches $150,000, when the allowable loss is eliminated.
Adding It Up
You might think of watching TV as a passive activity, but the tax code defines passive activity as an activity in which you do not materially participate, such as real estate rentals and limited partnerships. .
You also may be able to deduct the value of your rental property over a period of years. This is called depreciation, and is intended to reflect the wear and tear on a property and its contents over time. Depreciation applies to a home and its contents, but not the value of the land.
In summary, try to keep these simple rules in mind when considering possible tax advantages of owning a vacation home:
Tax considerations shouldn’t be the only reason you consider buying a vacation home. Hopefully, you’ll find lots of other ways to enjoy it, too.
We live in a busy, stressful world that seems to spin faster and faster with every passing day. Finding time to relax and do nothing, or relax as you participate in activities that you enjoy, seems to get more and more difficult as you deal with the obligations of home, kids, work, aging parents, and so forth.
There’s no question that it’s a lot easier to relax and enjoy when you’re removed from the situations that cause your stress. To that end, a vacation home that’s not too far away from your primary residence can be a real lifesaver.
Don’t Go There
Resist the temptation to do so much entertaining that your vacation home starts to resemble a bed-and-breakfast facility, with you as the chief cook and maid.
Sharing your vacation home with friends and family also can be very rewarding. A couple we know invites their whole family to spend the Thanksgiving weekend at their beach house on the Jersey shore. It’s become a family tradition that grows every year.
Another couple enjoys loaning their Florida vacation home to their grown children and their families during times of the year when the couple isn’t using the house. Although financial issues definitely will be factors in deciding whether or not to buy a second home, remember that there advantages that can’t be accounted for in dollars.
While you’d like to restrict the imagery concerning your second home to tranquil walks on the beach in the moonlight, or quiet afternoons on the lake with a fishing pole in your hand, things don’t always work out as we plan.
Some of the less-than-happy considerations you should think about before signing the sales agreement on a second home include those listed here:
Be sure to collect a refundable security deposit if you rent your vacation home to someone you don’t know. Consider renting only to people who have been referred by friends or acquaintances.
Not wanting to be gloomy pessimists, we’ll stop considering the less-than-desirable aspects of owning vacation property right here. The point is, buying a second home is not a step you should take without lots of careful consideration.
If you get a call or information in the mail offering you a free or greatly discounted vacation at a popular tourist destination, chances are that you’ve been targeted as a potential purchaser of a timeshare.
Timesharing, basically, is when individuals purchase the right to spend a specified amount of time each year at a specific place. Most timeshare agreements allow you to trade with owners in different locations.
Timeshares were hot commodities 15 or 20 years ago, and then became less popular for a while. Sales are on the rise again, however, increasing by 14 percent during the past 6 years. More than 1.7 million Americans currently own timeshares, according to the American Resort Development Association.
If a timeshare company identifies you as a potential buyer, it may offer you, your spouse or partner, and maybe some other family members a couple of free nights in a hotel or motel. It probably will throw in some other incentives such as free or discounted meals, shopping, and admission to area attractions.
The average timeshare owner is 49 years old, earns $70,000 in annual income, is married, well educated, and has children.
In exchange for the free stuff, you’ve got to agree to spend a couple of hours with a salesperson who’s trying his darnedest to get you to plunk down $10,000 or so to buy a time-share offered by his company. He’ll tell you why his timeshare company is the best, and show you catalogs of all the great places you’ll be able to visit when you trade timeshare locations with other owners. He’ll probably show you a couple of timeshare models that are nearby, and then ask you to commit on the spot to buying one.
If you’ve done your homework and decided that a timeshare is for you, you may enjoy one of these presentations and the opportunity to buy. Just remember, however, that many of these salespeople use high-pressure tactics and don’t give you the opportunity to sleep on your decision.
The average price of a timeshare is $10,500, which normally guarantees you the use of your timeshare for one week per year for the rest of your life. Prices vary based on the time of year you’ll use the unit, and its location and size. Buyers traditionally put down 10 percent, then pay the balance over the next 7 years.
For the privilege of owning a timeshare, you get to chip in for property taxes, general upkeep, furnishings, and maintenance. Those costs average about $400 a year. An upside, however, is that you can get a mortgage to buy a condo and deduct the interest you pay on it.
Timeshares are interesting concepts, and many people think they’re great. Most timeshare deals allow you to trade for different locations, allowing you to test out new spots without the cost of having to rent a house or hotel room while you’re there. Some timeshare deals allow you to buy a week a year and use one or two days at a time, making them attractive to businesspeople.
Don’t Go There
Most timeshare companies are happy to give you a loan, but they usually come at a much higher rate than a mortgage you could get on your own. Don’t be talked into taking a company loan.
According to the Better Business Bureau, you should keep the following tips in mind if you’re considering buying a timeshare unit.
For more information about timeshares, including secondary sales, check out the Timeshare Users Group online at www.tug2.net.
A drawback of buying a timeshare is that you might have trouble getting what you want for it if you decide to sell. New timeshares are being built constantly. The company that sold you your timeshare generally won’t buy it back, leaving you on your own to sell it.
There is a secondary timeshare market, which is something to consider if you’re thinking about buying a unit. You can get some terrific deals on timeshares that have outlived their usefulness and now are burdensome to the owners.
Timeshares have their own set of advantages and disadvantages, all of which should be carefully considered before you buy. Try to avoid the high-pressure sales that come along with those free vacations, or be well prepared with questions and background information before you get into that situation.