Should you buy a vacation home?

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The past few weeks here in the northeast have been brutally cold!  Temperatures are more than 30 degrees below normal.  In Baltimore, we came within a day or two of the most consecutive days below freezing in history!  My kids are running around this house screaming on a daily basis.  They are stir crazy already and it’s only January.  Another 6-7 weeks before spring arrives here.  I’m originally from Michigan.  My parents tell me it’s even worse there!  All of that no doubt has many people dreaming of a warmer climate.

I am sure you have taken a vacation in the past that made you think, “I could come here over and over again.”  Maybe you even strolled down to a local real estate office and met with a local agent.  “How much would a condo cost, you thought?”  After a pitch, in which you were half sold already, you purchased a second home.

The excitement was overwhelming.  You immediately began planning how often you would travel to your new vacation home.  How you would furnish it.  All the friends and relatives you would invite.  How you could rent it when you weren’t there.  It all sounds great.

Roll forward a couple years… you have now spent money upgrading the home, buying furniture, and stocking it with all the necessities.  You realize you now need at least two of everything between your primary home and your vacation home.  Apparently, when you are away for awhile, things just start breaking, even though no one is using them.  You begin to realize that three-hour drive in traffic to the beach or the 90-minute flight back and forth isn’t as exciting once you have done it 25 times.  In addition, you feel guilty visiting any other places because of the amount of money you have sunk into this home and it would now be cheaper to just go to your vacation home.

Your wonderful vacation home may now feel like a very expensive place where you spend as much free time fixing and cleaning things as you do relaxing on “vacation”.  You sure didn’t envision becoming the handyman and cleaning crew in addition to everything else when you go on “vacation”.

For many people, this is what ends up happening.  It’s great in the beginning, but once reality sets in, it’s just not that much fun.  You have now invested a lot of time and money.  You continue to pay even more.  Often times, a second home can become like a very expensive toy that you may get tired of playing with….especially when you start looking at the actual costs.  I have had numerous financial planning clients over the years where this type of experience occurs.  Thankfully, I have been able to help extricate them from the situation.  If this doesn’t describe you, great!  You are the minority second homeowner who did their homework, ran the numbers and has made a great investment.

Are You Thinking About a Purchase?

Here are some thoughts to consider when you are in the market for a second home.

  • Do you like the freedom to be able to travel to all kinds of different places around the country?  A vacation home may not be for you.  If you really only travel to one or two specific places, then you are an ideal candidate.
  • BEFORE buying a vacation rental property, try to assume the worst in your rental income calculations.  You should be willing to live with bad cash flow if buying a vacation home.
    • Ask yourself if you could afford it if the real estate market or the economy went into a recession?
    • What if the rental income completely dried up?
  • Consider a partnership with family or friends….but have clearly defined terms
    • Having an LLC for a shared property with people who share your views on the place can make things much more affordable and less stressful.  You will feel less guilty when you aren’t using the property.
    • A quality LLC Operating Agreement can spell out who can use the property and when, how the costs will be shared, and the sharing of property management.
    • If you don’t have procedures in place BEFORE the purchase, they may not be your friends any longer.
  • Even if you are not “partnering” with family or friends, owning the property in a Limited Liability Structure (LLC) is generally a smart practice.  By segregating the “vacation asset” from your other personal property, you are often able to reduce your personal liability if something unfortunate happens at the property.  Additionally, you may be able to claim various deductions related to operating the property in the name of the LLC.

Do you Already Reluctantly Own a Vacation Home?

Are you already in the regret phase?  Are you fighting with your vacation home partner?  Is the extended family still using the property at your expense?  Are you finding it hard to create the time to use the property?  Is the travel too burdensome?  Are the costs higher than you anticipated?  Unfortunately, there is no magic answer.  However, here are a few strategies to consider.

  • Try not to be emotional about the property
  • Run the numbers and take an honest look.  You may take a monetary loss after all the improvements, upkeep and selling costs but perhaps the reduction in stress would be worth it.  In addition to the costs of the property, don’t forget to factor in the travel costs as well.  If the numbers don’t make financial sense look to get out.
  • Maybe you have friends or family who also love the property and enjoy coming to visit.  Maybe it’s time to ask one or more of them to join you in ownership?  Make them a great offer.  Time to be honest, tell them they can’t keep using the property without sharing in the costs.  Make them a partner and create a great LLC to protect both you and them.  It just might be the perfect solution for your bank account.
  • Rather than sell, maybe its time to create some rental income.  After all, it is vacant more often than it is used.
    • It can be uncomfortable knowing that random strangers would be sleeping in “your” bed or using “your” couch, but if you can overcome those thoughts, generating some income might reduce some of those expenses.
    • This may create just enough cash flow to make the numbers work so that you can use the property during those special times of the year.

How to Rent Your Vacation Home Efficiently

  • Do extra research on the area rental market (find out if nightly or weekly rentals are allowed)
  • Is the property already part of a rental group, such as a condo or townhome community?
    • This can make renting much, much easier than a stand-alone home.
    • There may be a cleaning crew and booking agency, or both associated with the community.  This can save time in research and property management
    • There should be a track record of rental rates and occupancy history from the booking company.  It’s often referred to as “rent roll”.
    • Having a property that is “zoned” for rentals is important.  You really don’t want to be the only “rental” unit in a community and become known as “that house”.
  • If you are thinking of going the Airbnb route or renting nightly, you are most likely entering the “hotel business”.
    • Further due diligence is needed because you need to look at other available “nightly” rentals.
      • How much do they cost?
      • How often are they vacant?
      • How nice are other properties compared to yours?
  • Make sure to budget for repairs
    • Things do break…especially when people who don’t own the property are using it
    • Make sure to budget for those costs

Once you have done your homework, now is the time to work with a vacation property rental manager. Unless you are retired or have a lot of extra time on your hands to run spreadsheets, a solid property manager is a must.  Services such as HomeAway, VRBO, Tripadvisor and Airbnb offer tremendous platforms….for a fee of course.


Lastly, if you do follow these steps and create a great cash flow strategy for your vacation rental you do need to be aware of how that is taxed.  If you rent your property for less than 14 days during the year, your income is not taxable.  However, assuming you do,  IRS Pub 527 states “If you provide substantial services that are primarily for your tenant’s convenience, such as regular cleaning, changing linen, or maid service, report your rental income and expenses on Schedule C (Form 1040).  Substantial services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc.

Most rentals do not provide those nightly services, so income is placed on the Schedule E.  However, if you are providing nightly services (refreshed linens, cleaning, etc.), the IRS sees the rental property in the same light as a hotel.  All rental income needs to be reported on the Schedule C not the Schedule E.  Also, check to see if the local township charges a hospitality tax.  Either way, you will want to engage a qualified tax professional to advise you.

Hopefully, armed with this information, you will be able to make a smart, financial decision for you and your family regarding a vacation property.  When properly thought out and arranged, a vacation property can be a great investment.  However, often times, people are overcome with emotion about the prospects of owning a second home.  See the Forest Through The Trees and look at the bigger picture.  Once you have done the analysis, it should give you confidence in whatever decision you choose.  Cheers!


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