As you near retirement age, it can be tempting to invest in a second home in the vacation spot of your dreams. After all, the property’s value can appreciate over time, and you’ll have a permanent vacation spot for making memories with your children and grandchildren when you’re not renting it out for passive income. But is buying a vacation home really a good investment?
In reality, a second home may not be the cash cow you imagine it to be—and it might be more work than you want to take on, especially if you envision retirement as a lowkey time for relaxation.
Many people buy a vacation home with mixed purposes: to have a permanent vacation option in the place of their dreams and to earn a passive income from a real estate investment. Let’s take a look at a few points to consider before deciding if purchasing a vacation home in your retirement is the right choice for you.
Can You Afford a Vacation Home?
A vacation home is likely to come with quite a few costs. Aside from the purchase price, you’ll have other costs to consider, like:
Taxes
Homeowner’s association fees
Utilities
Maintenance costs (which will be higher in beachfront properties that take a beating from the salt and wind)
Insurance (which can be more expensive for rental properties)
Rental-management expenses (such as repairs, maintenance, and the cost of a management company)
Costs associated with owning a vacation property can be difficult to predict. Emergency repairs can erode your cash cushion. If you’re living on a strict fixed income in retirement, be aware that the costs of owning and maintaining a vacation home may rise faster than your cash flow allows.
A Second Home Is Treated Differently by the IRS
Remember that if you ever decide to sell the property, you’ll be subject to a capital gains tax. Unlike your primary residence (which allows for a capital gains tax exclusion of up to $250,000 for individuals and $500,000 for married couples), a secondary home generally isn't eligible.
To avoid this situation, many homeowners downsize by selling their primary home and moving into their vacation home. After they meet IRS requirements, that vacation home is considered their primary residence and becomes eligible for the capital gains tax exclusion if they decide to sell it.
Second homes can come with tax benefits, including a tax deduction on expenses such as:
Mortgage interest
Real estate taxes
Casualty losses
Maintenance
Utilities
Insurance
Depreciation
The deductions you can claim depend on how much you rent out the property versus how much you use it personally. It is important that you understand the tax impacts of a vacation home. Consider talking with a fee-only, fiduciary financial advisor who can help you assess the pros and cons of a second home in light of your entire financial situation.
Use for Rental Income Pre-Retirement
If you’re considering buying a vacation home as a retirement investment, odds are good that you’re thinking of renting it out to generate a bit of passive income.
If income is your primary reason to invest in a vacation home, it’s essential to compare your likely rental income with the costs, including mortgage, taxes, and maintenance and management expenses.
Some people find that the income just offsets the costs, and some people find the income falls short. You’ll want to do your homework on the home’s history as a rental, as well as the rental income generated by other homes in the area.
Do you plan to retreat there often? Many vacation properties are in areas with short-term rental seasons. Choosing to stay there yourself during the peak holiday season can conflict with your ability to earn the income you seek. Before you buy a second home, take the time to determine the appropriate balance between personal enjoyment and household income.
A Vacation Home Can Be a Complicated Investment
Before you make the leap into vacation property investing in retirement, make sure you consider the advantages and downsides to owning that property—and think about your motivations for buying the home.
If your primary motivation is to find a solid investment, make sure to do your research. You want to feel confident that you will earn at least enough income to offset the expenses.
Our Plantation, Florida financial planning firm generally recommends that you don’t put yourself in a position that you primarily depend on the investment property income for cash flow. Other income sources are important, such as your retirement plan distributions, pension, and Social Security benefits.
If you’re looking for a vacation getaway for your family and you have the financial means, a second home can be a great choice in your retirement as you create new memories with your loved ones.
Schedule a complimentary consultation with one of our fee-only financial planners to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.