What you should know before buying a vacation rental property

You may need to sort out a few factors before purchasing a vacation rental property. Since renting involves a specific approach.

When you purchase a holiday house or a vacation rental property, financing, taxes, and management problems are contemplated. Here is some essential information before you plan to purchase a second home in your dream holiday destination.

Do you ever wonder if you would be able to purchase a home in your dream holiday spot? Maybe you’ve had enough of renting and being charged hefty rent to lease a property. Or, the family will require more space than you can rent at a reasonable price in a resort or vacation rental. Or perhaps you simply desire a location where your family will gather whenever it is possible.

There are several compelling factors and locations to purchase a holiday house. On the other hand, when you make a financial plan, you must know enough about it, as many of them have numerous repercussions.

For instance, did you even know that mortgage loans for vacation homes and other non-primary households fall into separate categories? Or that property maintenance rates for vacation rentals may be three times higher than those for long-term leases?

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Is it possible to rent a vacation home?

“Yes,” is the straightforward response to this question. However, this could have significant tax consequences.

Understand the IRS detail of a vacation home that is occasionally leased as an investment portfolio. If you rent out a house, you have to occupy it for at least 14 days per year, or 10% of the total days you rent it out. If you do, the vacation home will be taxed as a secondary property. Otherwise, it is treated as an investment property by the IRS. This is the fact, whether you have purchased it specifically as an investment.

To begin, let us consider the most obvious consequences. Rental interest must be reported on a tax return regardless of how a leased property is listed. Additionally, you should exclude any expenditures. Consider earning $5,000 in rental revenue last year and spending $2,000 on land maintenance and repairs. Under this scenario, the taxable rental revenue will be $3,000.

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Suppose the IRS classifies your vacation home as an investment property. In that case, you are not qualified to subtract mortgage interest or property taxes. However, you can subtract those expenses from the net rental revenue to claim the investment property outcome variables. This will have a significant effect on the amount of tax you owe. Indeed, many lucrative investment assets generate a tax loss due to the several tax incentives available.

Bear in mind that financing an investment property may be far more complex and costlier than financing a primary residence.

The Internal Revenue Service (IRS) has a particular provision about assets that are rarely rented. To get the financial advantage of holiday property, you don’t have to declare any rental revenue or incur any taxes if you rent it out for 14 days or less per year. And if you have rented the house and earned $2,000 in two weeks, the IRS would have no legal way of getting their hands on a single penny.

Read more: Keeping your vacation rental

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Are you permitted to rent a vacation home?

Another issue to address before making a bid is whether you are permitted to rent the property at all. Numerous tourist spots have rental limitations. 

Specific condos and homeowners’ associations (HOA) also impose rental limits. We looked at several condos, and some of them prohibit renting unless you own the property for at least a year. This prevents individuals from purchasing units solely for investment purposes. Some locations prohibit short-term rentals entirely.

It’s a good idea to find out ahead of time whether it is legal to rent your vacation home or not. Many municipalities and county governments impose penalties for unauthorized rentals. A realtor may be able to help you determine if a specific property is available for rent or if there are any prohibitions.

Would you get the very same tax benefits for a vacation home as you do for a primary residence? Mortgage premiums and land taxes may be deducted the same as your primary house. It varies on how much you are charged each week. If you rent it out, you can use it as a vacation house. Remember, it would lead to more outstanding outcomes.

If you buy a condo on the seafront that you rent out for 6 months a year. To qualify as a vacation home for tax purposes, the property must be occupied by you for at least three weeks per year.

You will subtract the property taxes for your primary and vacation homes. However, the SALT (state and local tax) exclusion has been reduced to $10,000. It includes the actual real estate taxes as well as any additional property taxes. If you have multiple residences, it’s not uncommon to have taxation that surpasses the limit.

It is helpful to know about the tax break you get on a vacation home. When you have to sell a primary home, you will deduct up to $250,000 in investment losses. The profit you make from selling your primary residence won’t be taxed.

If you had to sell your house, you’d likely face a tax liability of $100,000. A six-figure profit is unquestionably a desirable situation to be in. However, keep in mind the tax consequences.

So, you’re all set for buying a vacation home. Therefore, here is a rundown of the benefits and drawbacks to be aware of.

Read more: Managing rental properties

Advantages of purchasing a vacation home

Many people believe that buying a holiday home is an expensive and significant choice. Before you make up your mind, it is necessary to comprehend the advantages and disadvantages.

To give you a better idea of what is offered, we will begin with the advantages. Below are among the most lucrative benefits of purchasing a holiday home.

If you travel frequently, you can save money in the long run. Suppose you spend two months during the summer at the beaches per year. In that case, the average mortgage expenses will be equal to the cost of renting a house during those other times. Additionally, you’ll be accumulating wealth over time rather than handing over the equity to someone else.

You will be able to rent out your vacation home while you are not there. This might turn the property into a significant revenue source for holiday destinations. Let’s continue and discuss this further before we move into it.

Real estate prices, especially in famous vacation destinations, increase with time. Even if you do not rent it out, your vacation home will contribute to your wealth accumulation.

You could be eligible for tax deductions for mortgage payments and real estate taxes if you do not make effective use of your vacation home for business purposes other than personal use.

You will have the option of customizing your holiday home to meet your needs and desires and even store belongings there. For instance, if you own a beachfront house, you are not required to transport your beach chairs and children’s beach toys on every trip.

When you can afford to purchase, a vacation home will finally transform into a full-time residence. Purchasing a holiday home while still in your twenties can provide you with a desirable retirement location.

Of course, there are practical considerations to owning a vacation home, such as providing a spot for the whole family to get away together. Everybody desires a holiday home for a variety of reasons.

Read more: Vacant home insurance

Disadvantages of purchasing a vacation home

Owning a vacation home has several disadvantages and is not suitable for all. With that in mind, it’s important to remember the following before making a purchase:

Vacation homes are costly, much more so in trendy destinations. The average prices of the houses in your favorite location may be quite expensive compared to your primary residence.

Apart from the lease, you’ll be responsible for house taxes, premiums, insurance, and other costs associated with the residences.

Financing vacation homes can be challenging. Obtaining financing for a holiday home may be intimidating as well. People are generally charged more for taking loans and asked to make a larger down payment for commercial real estate than they might expect for a primary residence.

You are accountable for all the repairs and maintenance. You’ll have to take care of maintenance work yourself or hire others to do it.

Real estate, on the other hand, is not a liquid resource. It may be challenging to sell a house instantly without accepting substantially less than the house was worth. Many financial advisors recommend against purchasing a vacation home or some other kind of real estate unless you want to keep it for at least 5 years.

Read more: Turn guest house into an Airbnb

Conclusion

Purchasing a vacation rental property may be a strong source of long-term cash flow and a consistent revenue stream of profits. To do so, you would have to put forth the effort and focus on the process.

Read more: Top tips for your vacation home maintenance

Written by Billy Guteng. April 18, 2021

Billy was born in France, and has lived in multiple cities around the world ever since. He loves art, design and architecture and he supports the KUKUN team as a content provider.