Should You Buy a Vacation Home?

Justin Rodriguez, CFP®

Jun 12, 2024

When the temperatures here in Phoenix start rising each year, desert-dwellers share one thought in common: It’s time to escape for a while. For many, dreams of owning a getaway in a more temperate climate, whether cooler or warmer, abound.

Some years ago, clients of ours built a cabin in the White Mountains of northeastern Arizona, to be near other family members who also had a vacation home there. This husband and wife are not fans of winter weather, but during their working years they spent as many summer weekends at the cabin as they could. After retirement, they were able to spend even more time there, and loved it. Eventually, as their children moved several states away, their priorities changed. They wanted to have more time and financial flexibility to visit their children and travel more widely, so they sold the cabin and used part of the proceeds to fund these new goals. They enjoyed their summertime escapes to the cabin while they had it, but when their lives and circumstances changed, they pivoted.

For some people, like these clients, the experience of owning a vacation home measurably enhances their quality of life. For others, however, it’s not a good fit and can result in significant financial and emotional stress. When you’re excited about buying, it’s usually easier to think of all the pros rather than cons but both deserve careful thought, so if you’re eyeing that cabin in the cool mountains, or that golf-community condo in the warm, sunny desert, read on for issues to consider.

First, let’s clarify that in this article, we’re discussing a dwelling unit that you use as a vacation home and at which you spend measurable amounts of personal time, not a rental property that is used solely for investment purposes.

What’s Your Why?

As with all big decisions in life, it’s smart to start with your “why” when you’re thinking of purchasing a vacation home, and then fact-check your expectations.

Why does owning a vacation home call to you? There can be many good reasons—a change in climate, proximity to nature and outdoor activities you love, a way to be closer to family and friends for part of the year, or a legacy goal of creating a multi-generational family retreat, among others.

Are you seeking to escape the heat of a desert summer or the cold of a mountain winter? If so, consider the climate and amenities in the location you’re considering. What’s it like in the off-season? For example, mountain towns are appealing, but if you don’t like snow and cold temperatures, you may find there are limited months of the year when you want to be there. Depending on the area, many of the nearby amenities open during the summer may close in the winter, making the area feel more isolated.

In addition, make sure you understand the attributes of the area in which you’re considering buying. Are there a lot of activities you like to do there?  Is it as close as you’d like to be to conveniences such as grocery stores, restaurants, and gas stations?

How often will you realistically be able to get there? Some Phoenix residents own summer homes in Flagstaff, but that can be a tough commute to do weekly during the hottest months because of heavy traffic on the main route to Flagstaff. If you’re retired or work remotely, the calculus would be entirely different, because you would likely be able to spend much more time at the vacation home and travel time would not be such a burden.

We often recommend that clients interested in buying a vacation home rent a property near their targeted area for a season or even two, before they finalize their decision. This gives you a trial run and an opportunity to evaluate the town and neighborhoods, before you commit to a much larger financial outlay.

Beloved Family Retreat, or Obligation?

If your goal is primarily to move closer to family and friends or provide a space for those you love to gather in, consider how much time you’ll be able to spend with those people and whether that will change in the future. You may find you don’t enjoy the vacation home as much when the family and friends you wanted to be closer to can’t be there.

If you plan for this to be a legacy property you can pass on to future generations, talk with your heirs first to make sure this idea is welcomed. They may not love the location that calls to you, and the logistics of maintaining the home may come to feel like an unwanted emotional or financial obligation to them after you pass away.

Is There Time and Money for Other Desired Travel?

If you buy a vacation home but also love to travel the world, you may end up feeling conflicted. Having made such a major investment, you’ll feel duty-bound to spend significant time at the vacation home. Will this leave enough time for other traveling you may truly value, and will you be able to afford those travels given the costs entailed in owning the vacation home?

Can You Afford a Second Home?

One of the most basic questions to consider is also the most obvious—can you afford a vacation home and the ongoing expenses associated with it? Be sure to talk with your TCI advisor about the potential costs involved, so that they can model them in your financial plan. This will help you understand the impact the purchase may have on your other goals.

Obviously, you’d like the home value to appreciate over the years, so take time to evaluate the location, economic conditions, and housing demand in the area you’re considering.

If you’re financing the purchase, be aware that interest rates for second homes are somewhat higher than those for primary residences, and you may need to put more money down at the outset.   Even if you’re paying cash for the home and don’t have to deal with higher rates, many desirable locations have rapidly appreciated since the pandemic and the increase in remote working, so homes in those areas may be pricey.

Beyond the cost of the purchase, you’ll need to think about real estate taxes, repairs, and maintenance costs, and how those will fit into your budget. Can you easily afford an unexpected, major expense such as new windows or a new roof, or a steep increase in ongoing costs such as property taxes or homeowner’s association fees, without putting your essential goals and financial plan at risk?

Speaking of unexpected expenses, it’s always a good idea to have the home inspected by a professional before agreeing to buy it. It will help you identify any major repair issues that might not be apparent, inform your buying decision before you commit, and assist you in budgeting for major future repairs and maintenance if you do proceed with the purchase.

Potential Income Tax Impacts

If your days of personal use qualify the vacation property as a “home” according to the IRS definition, and you’ve rented it for 14 days or less per year, no worries—you don’t have to report any of the rental income. Any mortgage interest and real estate taxes are reported as itemized deductions and subject to normal limitations.

Things get messier when the property qualifies as your home, but you also rent it for 15 days or more during the year. You will need to report all your rental income for tax purposes, and your expenses related to the property must be prorated between rental and personal use. Rental expense deductions will be limited to the amount of your rental income, and any excess rental expenses can be carried over to the following year but are still subject to any deduction limits that apply to that year.

Sound complicated?  It certainly can be, so be sure to consult your tax advisor and IRS Publication 527, Residential Rental Property, which covers the rules for the rental of vacation homes.

Lastly, keep in mind that on a second home, there is no capital gains exclusion as there is on your primary residence. The entire gain will be taxed, but if you’ve owned the home for at least one year before selling, the gain will be subject to the long-term capital gains rate, which is usually lower than your ordinary income tax rate.

Your Circumstances Are Unique

Whether or not to buy a vacation home is a discussion that we have with many of our clients. It’s a very individualized decision-making process, and we’re here to help you run the numbers and think it through. The points above are not meant to steer you away from a vacation home purchase. Rather, they’re intended to help you consider both the pros and cons of a very impactful decision so that regardless of the outcome, you’ll know you made the very best choice for your unique circumstances.

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