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 Work hard, play hard - we've all heard that expression. But the real estate market is telling us that people are putting their money where their mouth is. More than ever, people are rushing out and buying a second home along coastal towns and resort communities.
According to the National Association of Realtors, when asked for the reasons for buying a second home, the majority of people answered vacation (51%), followed by retirement (18%), investments (16%) and rental income (15%). With the laws of supply and demand always at play, the surge demand for second homes has fueled a booming real estate market in coastal and resort areas around the country.
Investing in a Second Home
Regardless of the reason for buying a second home, the fact remains that most individuals also view that home as an investment - one that is a little more complex than a buying a stock or bond. That's because unlike other investments, homes usually don't appreciate or depreciate in value quickly.
Appreciation in Home Values
Homes can also be difficult to sell in a down market making liquidity a problem if you need to cash out on the investment. You can try to hedge against a down market by sticking to some of the same home buying principles you followed when buying your primary home - for the most part, location remains the golden rule.
In the same way that school systems and access to transportation increases the value of your home, there are things to consider when investing in a second home or vacation home. No doubt you want to take a look at how close you are to beaches, golf courses, lakes, mountains and other recreational areas.
But also keep in mind the things that may not be so obvious when assessing a vacation community. Make sure there is adequate access to the area including highways and public transportation. And you also need to prepare for the unexpected. This means access to hospitals and other health care facilities.
Tax Implications of Owning Second Homes
The tax experts tell us that a second home is defined as a house, condominium, house trailer and a boat if it has all the essentials such as a sleeping area, cooking and bathroom facilities. These same "tests" also apply to recreational vehicles that may also qualify as second homes.
Tax Deductions
If you're able to itemize deductions on your tax return, then the interest expense on your second mortgage is tax deductible. The exact deduction that you can take on your taxes may be limited if the mortgage exceeds the fair market value of the home. In addition, if the total of all your mortgages - second home and primary residence - is in excess of $1 million ($500,000 for married, filing separately), then you may not be able to deduct all of the interest expense on your federal income taxes.
Real estate or property taxes are also deductible on your second home if you itemize your deductions. In addition, any mortgage points paid when buying a second home are deductible over the life of the loan.
Rental Income from Second Homes
Even though it is not explicitly stated as one of the primary reasons for buying a second home, many buyers do rent out their homes for a good part of the year. At the low end of this scale, you can rent out the home for two weeks of the year without paying any tax on the rental income. That's quite a tax break for owners of second homes.
If you're thinking of renting out the home to pay for the mortgage and other costs associated with owning that second home, just be forewarned. While renting out your vacation home can help to lighten your financial burden, rental income almost never completely covers the cost of the mortgage and maintenance of the home.
Taxes and Rental Income
The exact tax rules that apply to rental income really depend on whether or not you use the second home as a residence. A second home is considered a residence if you or a family member use the home for personal reasons for more than 14 days each year, or 10% of the number of days that the home is rented (at fair market value) - whichever is longer.
If you rent the home for more than 14 days, then you must report the rental income on your federal income tax return. You can report and deduct your rental expenses up to the amount of the rental income you're claiming. If you itemize deductions, then interest expense and taxes that are in excess of your rental income can also be deducted on your taxes.
The above rules do not apply if you don't meet the residence test mentioned above. In that situation, you would report the income and expenses in the same manner as you would with other rental properties you might own. For example, the only expenses you can deduct include taxes, interest and casualty losses that are attributed to your use of the second home.
Financing a Second Home Purchase
If you're thinking about buying a second home but your not sure if you can afford it, then you might want to take a look at our mortgage calculators. Those calculators that might be helpful with this decision include:
About the Author - Buying a Second Home
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