Vacation Home vs Investment Property: The Differences in Taxes, Goals & More
Are you considering purchasing a second property but need help deciding whether to buy a vacation home or an investment property? While both options can provide potential financial benefits, they have different purposes, advantages, and disadvantages. This guide will explore the differences between vacation homes and investment properties, including their potential for financial gain, management responsibilities, tax implications, and more.
What is a Second Home?
A second home is a building that can be utilized as a living space for some of the time but not as one's main home. These homes are typically vacation homes, though for some days of the year, it could be rented out for some additional income.
Second homes often require a larger down payment than primary residences because lenders view them as higher-risk investments due to their lack of occupancy. Mortgages and home equity loans for second homes usually carry higher interest rates than those on primary dwellings.
Note that there are specific rules for renting out your second home regarding how many days it's allowed. Generating revenue from a second residence involves extra effort, such as marketing the property online or through local real estate agents and handling maintenance requests from tenants—both of which require additional resources depending on how much help is enlisted from professionals.
What is an Investment Property?
Investment properties are usually secondary residences for the purpose of gaining capital profits or generating income. This can be in the form of rental income from tenants or from taking advantage of home equity and other mortgage interest benefits. Ski town vacation homes make great investments, evidenced by the amount of real estate investment such areas have seen in recent years.
When considering an investment property, you must think of all the factors associated with owning it versus your primary residence. For example, when buying an investment property, you may need to pay higher mortgage rates than for your main home since lenders view these loans as riskier investments due to their lack of occupancy. You will also likely have more stringent lending requirements, such as larger down payments and proof that you can afford both mortgages if applicable.
Another factor to consider is taxes; while some states offer tax breaks on rental properties, others may charge additional fees based on projected rental income or market value increases over time. Property taxes are typically higher on vacation homes than they are on primary residences, too, so keep this in mind before making any decisions about investing in a second home.
One of the top considerations when buying an investment property is the anticipated return on investment over time—whether it be through rental income or appreciation. It is important to factor in all costs associated with owning an investment property, including insurance premiums, maintenance expenses, and legal fees, so you don't end up losing money instead of making a profit.
Key Differences Between Second Homes and Investment Properties
Second homes are typically used for personal use, while investment properties are purchased to generate income or capital gains. Second homes may be subject to different taxes than investment properties. For example, owners of investment properties can often write off expenses like maintenance and utility bills, whereas they usually can't with second homes. Mortgages for second residences often require lower down payments and interest rates than those on investment properties, as the latter carries more risk.
Investment property owners also need to consider rental income when determining whether they can afford the monthly mortgage payment. To do so, lenders will often require an appraisal that estimates projected rental income and other factors before approving a loan application. Additionally, investors should keep in mind that if they plan on renting out their property, they may be responsible for paying taxes on vacation rental income and insurance premiums on top of their regular mortgage payments each month.
Can a Second Home be a Tax Write-Off?
In certain situations, a second residence may be qualified for tax reductions. Generally, if the second home is utilized as an investment or rental property, it may be eligible for deductions such as mortgage interest and real estate taxes. Homeowners may be able to deduct expenses associated with running and maintaining the residence if they utilize it personally for more than 14 days or 10% of total rental days, whichever is more. However, these rules are complex and vary by state, so homeowners should consult with a qualified tax professional before making any decisions about their potential write-off eligibility.
Vacation Home or Investment Property: Which is Best for You?
When deciding between a second home or an investment property, it is important to consider each option's various distinctions and implications. From taxes and mortgages to rental income, each situation is unique and requires careful thought before making any decisions. Knowing these distinctions can help you make informed choices when buying a second home or an investment property.