What is a Vacation Home?
A vacation home is a secondary dwelling separate from the owner’s primary residence, primarily used for recreational purposes like vacations or holidays. Often referred to as a recreational property or a second home, these are typically situated in a different location than the owner’s primary home. The limited use often prompts owners to rent out these properties when not in use.
Key Takeaways
- A vacation home is a secondary property besides the primary residence used mainly for vacations.
- Usually located away from the primary home.
- Can be rented out for extra income when not being used by the owner.
- Comes with operational costs such as property taxes, insurance, and maintenance.
- Shared ownership options like a timeshare fall under vacation homes.
Understanding Vacation Homes
Homes can be classified into different categories, primarily for tax purposes. The property where the homeowner resides is called the primary residence. This includes types like homes, apartments, condos, or trailers, as long as the owner lives there for the majority of the year.
A vacation home, however, serves different purposes. This secondary abode is often located in a different city or region and is used for leisure. Similar to primary residences, vacation homes can take the form of cottages, condos, or even cabins.
Renting Vacation Property
Vacation homes not only serve as a getaway but can also generate additional income by renting them out. For instance, a couple living in Maine might own a vacation home in Florida. They may stay there during Maine’s cold months and rent it out for the rest of the year.
While appealing, vacation homes can be financially strenuous. Mortgage rates for vacation homes are usually higher, reflecting the higher default risk compared to primary homes. Renting out these properties doesn’t necessarily offer stable rental income, so owners must prepare for financial strain during unrented periods.
Tax Implications of Renting Vacation Property
To be classified as a residence by the IRS, a vacation home must offer basic living facilities like sleeping quarters, kitchen, and bathroom. It must also be used personally for more than 14 days a year or 10% of the days rented.
Short-term rentals through platforms like Airbnb or Vrbo can also influence this classification. Deductible costs for rental purposes include home mortgage interest, real estate taxes, and casualty losses. If rented out for 15 days or more per year, rental income must be reported to the IRS using Schedule E, along with deductible expenses.
Financial Implications of Owning a Vacation Home
Owning a vacation home comes with several ongoing financial responsibilities:
- Mortgage Payments/Interest: Regular payments on the mortgage, with interest heavier at the initial stages of the loan.
- Property Taxes: Often billed annually or semi-annually, influenced by property value and location.
- Repairs/Maintenance: Upkeep expenses include cleaning, landscaping, and necessary repairs or upgrades.
- Consumables: Budget for replenishing items like groceries each visit.
- Insurance: Required to safeguard against damage or theft.
Additionally, vacation home values fluctuate based on economic conditions, affecting their market price.
Selling Vacation Property
Selling a vacation home often requires reporting to the IRS, with gains taxed as personal capital assets. Unlike primary residences, which benefit from a tax exemption up to $500,000 for couples, profits from selling vacation homes are subject to capital gains tax.
Challenges of Owning Vacation Homes
While dreamlike, vacation homes come with challenges like maintenance, which can be tough if located far from the primary residence. Issues like natural disasters or the inability to fulfill personal visits may add stress. Additionally, the financial strain of inconsistent rental income can also pose a challenge.
Vacation Home vs. Investment Property
Vacation homes can double as investment properties when rented out. However, investment properties don’t require personal use and can be any type of real estate used to generate income.
Vacation Property vs. Timeshare
Although similar, timeshares typically involve partial ownership, where you can use the property for a specific timeframe annually. Timeshares are more affordable but offer less control compared to complete ownership of vacation homes.
Is It Smart to Own a Vacation Home?
The suitability varies by individual. For those with sufficient disposable income and frequent use, vacation homes can be rewarding, despite potential financial burdens.
How Far Is Too Far for a Vacation Home?
This is subject to personal preference. Consider your typical stay duration and practicalities in terms of travel time.
How Much of Your Net Worth Should You Spend on a Vacation Home?
Financial advisors frequently recommend capping this around 10-15% of one’s net worth. Ensure any investment can be supported by regular income.
Can I Live in a Vacation Home Year-Round?
Technically, you can, but it accrues different tax implications depending on the duration of residence.
The Bottom Line
Vacation homes offer escapism and potential rental income but come with ongoing costs and financial uncertainties. Evaluate how often you’ll use it, IRS definitions, and consider total ownership costs before investing.
Related Terms: secondary residence, recreational property, timeshare ownership.
References
- Internal Revenue Service. “Publication 523, Selling Your Home”.
- Internal Revenue Service. “Instructions for Schedule E”.
- Internal Revenue Service. “Publication 527, Residential Rental Property”.
- Internal Revenue Service. “Topic No. 415 Renting Residential and Vacation Property”.
- Internal Revenue Service. “Instructions for Schedule D”.
- Internal Revenue Service. “Topic No. 701 Sale of Your Home”.
- U.S. Census Bureau. “Historical Census of Housing Tables: Vacation Homes”.
