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4 Things to Know Before Buying Your First Vacation Home

Posted by Pete Deininger on Wednesday, April 27, 2022 at 9:45 AM By Pete Deininger / April 27, 2022 Comment
What to Know About Buying a Vacation Home

Those who find themselves returning to the same destination year after year to spend their leisure time often find purchasing a vacation home or condo a worthwhile investment. However, deciding to buy a vacation home is a personal decision not to be taken lightly.

Home seekers should consider various factors, such as lifestyle, vacation style, monetary goals, tax implications, and other logistics associated with purchasing a secondary residence. Before plunging into vacation homeownership, read on to learn everything there is to know about buying a vacation home.

How to Decide Whether to Buy a Vacation Home

Buying a vacation home can be a great investment as long as you take a few preliminary steps. Vacation home buyers can start by assessing their lifestyle and potential ownership goals. The first question to ask oneself is what kind of location is desired. Is it an oceanfront home, lakefront cottage, urban condo, a cabin in the woods, or a mountain lodge? Do you want to be near major attractions, such as national parks, nature preserves, or theme parks? Once the desired vacation area is chosen, buyers should ask themselves the following:

  • Will the home be visited often enough to warrant making a purchase to offset spending money for hotels or renting the homes of others?
  • Will the home be utilized as passive income to help pay down the mortgage?
  • Who will manage or maintain the property during the owner's absence if purchased?
  • What is the likelihood of wanting to go to this location in five years, ten years, or longer?
  • Will the home be utilized as a retirement property?
  • What does the current local real estate market look like?

Other steps home seekers can take is to stay in the area during different times of the year before buying. This test run can help determine if the area is genuinely desirable enough for homeownership. Additional steps to take can include speaking to neighbors to find pros and cons and determining what off-seasons are like.

How Buying a Second Home Is Different from a Primary Home

One of the tricky factors associated with purchasing vacation homes is that new owners are sometimes caught off-guard by the different rules or tax implications of secondary homeownership.

For instance, obtaining a mortgage is different for vacation homes. Because these properties don't qualify for other low-interest loans (like an FHA loan), vacation home seekers need to explore other options. They can obtain a traditional second home mortgage based on income, credit score, and down payment. That being said, rental homes are often more challenging to obtain a mortgage than secondary homes intended to be used by the owner. Lenders typically require up to 25% down before approving a vacation home mortgage.

Another option buyers can utilize is to leverage the equity in their primary home with a HELOC loan. However, the biggest drawback is it can put the primary property at risk if the loan defaults.

Industry experts often recommend working with a lender specializing in vacation homes in specific regions who understands the local rules.

Vacation Homes vs. Investment Properties

There's a Tax Difference Between Vacation Homes and Investment Properties

The IRS has different rules relating to vacation homes and investment properties, and it's sometimes a complex process to sort out these differences. Speak with an experienced accountant or tax advisor when purchasing a second home who can advise on the best strategies to invest in vacation properties. Otherwise, buyers may end up with unaffordable tax obligations on top of the other added expenses associated with owning a secondary home.

For instance, what happens if, in a few years, the owner decides to sell the vacation home or condo? Owners could pay a hefty sum to the IRS in capital gains tax when selling their property, especially if it has significantly appreciated or has been rented out for most of the time during ownership.

Capital gains tax rules are different for vacation homes versus primary homes. The IRS has what's referred to as the "2-in-5-year rule," which determines which home is an individual's primary residence. IRS rules dictate capital gains exclusions are primarily associated with primary homes, but there are exceptions. For instance, owners who live in their second home for at least two years (or 730 days) can qualify a vacation home as a primary residence—and the time doesn't need to be consecutive. Investment homeowners cannot utilize this tax option. On the other hand, rental income is taxable income, and there are specific rules associated with this as well that need consideration.

Vacation homeowners renting their homes can also benefit from tax write-offs, such as passive activity loss rules and depreciation. Depending upon the amount of time they spend in their home, they may or may not qualify for some tax write-offs. Therefore, it's always important to check with a trusted advisor to determine if the home will be considered a vacation home or an investment property.

Things to Know Before Buying a Vacation Home

Aside from lending options and tax issues, buyers will want to consider other localized rules associated with the property before making this significant financial commitment. For example, if planning to rent a home out, find out if there are any HOA rental restrictions. If not, this could be a financial challenge if the owner's strategy was to recoup money through rental income.

Other considerations include property management and the fees that come with it. Someone will need to maintain the property when the owner is away, and if owners don't live locally, they'll need someone trustworthy and reliable to manage the property in their absence.

Another essential factor to think about before leaping into vacation home ownership is what the area is like in the off-season. Is it rentable, or is the area less visited during certain times? This won't matter for some owners if they plan to use it year-round, but for people heavily relying upon rental income, this is a critical factor for them to consider.

Get Ready to Buy Your Vacation Home

Buying a second home can be a great joy for people, but it's crucial to consider all factors before signing on the dotted line. Vacation homes open up opportunities for passive income, but they also have different rules for taxes and considerations for maintenance. Once a homebuyer knows what to expect, though, their dream of a vacation home is well on its way to becoming reality.

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