Tax Considerations Of Vacation Property Versus Investment Property

Dated: 12/06/2017

Views: 121

If vacation has been so much fun that you don't want it to end, a second home might be for you. Think carefully about all the issues surrounding owning a second home, however, because there can be major financial implications.

Investment property vs. vacation home

The most important decision is whether your home will primarily be an investment or a true second home. How you use the home throughout the year will determine how it is classified by the IRS. A true second home is one that only you and your immediate family use.

It's tempting to help cover your expenses by renting out the home to other vacationers while you're not using it, but in the eyes of the IRS, you may have just become a real estate investor.

Tax implications

You can't write off the mortgage interest on an investment property in the same way you do your primary residence, and you must report the rent you receive as income. In certain situations, you may be able to offset the rental income with deductions for interest, taxes, depreciation and home maintenance.

The catch is that the IRS is very interested in the number of days you use the home for personal use each year. If you use the home frequently, you can deduct only the expenses that are proportional with the amount of time you rented out the home. Also, if you rent the unit below market value to friends or family members, the IRS might consider that to be personal use.

As you can see, your tax situation can get complicated in a hurry. Consult a tax adviser before you buy, so you can be sure you understand how the new home will affect your bottom line at tax time.


Financing a second home also can get complicated. If you have an FHA loan on your primary residence and took advantage of the low-downpayment option, prepare to cough up more cash for a second home than you may be expecting. Because private mortgage insurance won't cover a second home or investment property, you'll need to put down at least 20 percent.

FHA only insures loans on primary residences, so your second home loan will have to be a conventional loan. This means tighter lending standards, particularly when it comes to whether you can afford the payments. Lenders will look closely at your income vs. housing expenses on both homes and may require strict adherence to debt-to-income ratios. Be prepared to show that your income is sufficient to keep both homes afloat.

Other considerations

Add up all of the costs before putting in an offer. Don't forget utilities, home maintenance costs and overhead that can add up, such as furnishings and decor. Also think about how much it will cost to travel back and forth to the home.

If you will rent out the home while you're away, don't forget about property management fees, and be sure to research average local occupancy rates so you're prepared for periods with no revenue.

If you get in over your head, your "dream" vacation home could become the stuff of nightmares.

Courtesy © The Daily Progress, Charlottesville, VA, Anna Changyen

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