When a second home may prompt second thoughts: Guest view
It is summer, which leaves hot and humid days ahead of us until fall. If you're not a fan of Central Pennsylvania summers, you may be dreaming of a house on a lake in the Poconos, a small row boat knocking up against the dock, and you may imagine yourself relaxing in an Adirondack chair, enjoying cooler air held in place under oaks and pines.
Or maybe your dream home is beachside and a few hours away by car. Maybe you’d prefer to be a little farther away, by plane.
Many Americans have a second home and many more may be considering the financial implications of buying a vacation property. According to statista.com, the number of Americans who said they lived in a household that owns a second home, as of spring 2017, was 9.26 million.
Before diving into a significant purchase, one that will likely impact your finances for many years to come, it is worth considering all the angles.
The first step in assessing the viability of a second home is to understand how you expect the property will be used.
Personal enjoyment is a given, but purchasing a home for this reason doesn’t rule out the possibility of limited rental opportunities.
Renting a vacation home for a period of less than 15 days a year allows the property owner to receive rental income without having to report it. If your home is near a big annual event like a golf tournament, you might be able to rent your property for less than two weeks at a premium and pocket the proceeds.
In the vacation business
If you plan to purchase a home in a region where you’d like to eventually retire but you’d prefer to rent it out in the meantime (more than 14 days a year), you will have to run your property like a business. This means that income must be reported to the IRS, but so can expenses.
As long as owners do not use the property themselves for more than 14 days or 10 percent of rental days, whichever is greater, they are often able to write off all maintenance costs, repairs and depreciation on the property. If an owner rents the property for 10 months of the year, personal use of the property cannot exceed 30 days for the year (10 months = 300 days, 10 percent of 300 = 30).
If an owner rents for more than 14 days in the year and uses the property personally for more than 14 days, expenses are deductible in proportion to the relative amount of time rented.
To the extent that expenses outpace income, you may see tax savings that make an underperforming rental a worthwhile endeavor.
Second home as investment
You and your family may fall in love with a property while vacationing out of town, and at first blush, the property may appear priced to sell. But have you considered the costs?
Maintenance costs apply to every home and must be considered part of the overall return on investment. Does the home have a pool that would be your responsibility? How much will landscape maintenance cost? What are the association fees? Is your home in a flood zone and prone to frequent repairs from flooding? What about insurance costs?
Borrowing costs can be higher for second homes as the interest rate can be higher than it would be for a primary residence. And the down payment may be higher, too.
Travel costs vary wildly depending on whether you can drive to the home or must fly to it. All costs, including travel costs, must factor into a final decision.
Taxes and the new normal
With the passage of the Tax Cuts and Jobs Act in late 2017, the tax rules have changed and they may reduce the financial benefit of a vacation property for many families.
Until this year, mortgage interest deductions had been offered on the first $1 million of lending across a first and second home.
The new tax bill lowered the mortgage interest deduction to $750,000 for all new-home purchases made after Dec. 15, 2017. Those who before that date had a primary residence and one vacation home with mortgages up to $1 million should suffer no change in their ability to take the interest deduction on the entire $1 million.
The $10,000 cap on deductions for state and local taxes may also play into a decision to buy a vacation home.
This is not a comprehensive list of what must be weighed to ensure a prudent decision for your family. Your attorney, CPA and financial planner should be consulted prior to any big purchases.
Anthony M. Conte is managing partner at Conte Wealth Advisors based in Camp Hill. He can be reached at firstname.lastname@example.org.