The Basics
Many families dream of a cabin in the woods or a house at the beach. But the costs and aggravation can be more than you expect.
Financial planner Ross Levin and his wife bought a vacation home to enjoy with their children even before they had any children. The Minneapolis couple envisioned countless family weekends and holidays at the lake as their kids grew up.
The Levins twin daughters are now 10, but, on most weekends, soccer or birthday parties preclude the family from venturing north.
Were not using the home as much as we thought we would, mused Levin. We might not like it, but friends become a bigger part of their lives than their parents.
The realities of owning a second home are often far different from the fantasies, say many second homeowners and financial advisers. Among the typical surprises:
It cost more than we imagined.
Were using it less than we planned.
The area isnt what we thought it would be.
Were having more conflicts than we anticipated.
Nationally, the interest in second homes may be cooling. Only 4% of all homes purchased in the first quarter of 2003 were second homes, according to the National Association of Realtors, down from 5.5% of all purchases in 2001.
That doesnt mean you should forgo that cabin in the woods or the palazzo on the beach. But the happiest second-home owners are those who are realistic about what theyre getting into. Here are 10 tips to help you become a happy second-home owner.
Know yourself
Are you the kind of person who loves to visit new places or who revels in hotels that cater to every need? How are you going to feel about having to go to the same place over and over again, or having to face a big pile of laundry and dirty dishes at the end of every stay?
Peripatetic types could opt for a recreational vehicle as a second home instead of a stationary abode. But divas who dont budget for maid service are likely to be miserable.
Think it all the way throughMany second-home buyers expect to own their properties for the rest of their lives, but few vacation properties are that flexible.
The cozy lakeside retreat thats perfect for a childless couple might be too small or hazardous for toddlers or too isolated and boring for teenagers. Similarly, your high-schooler might revel in a hopping beachfront location that will be way too congested and noisy once youre retired.
In fact, the very attributes that draw you to a place may turn out to be its biggest disadvantages. Planner Nancy Langdon Jones of Upland, Calif., said her husband has long agitated for a secluded cabin in the mountains, especially now that the couple is nearing retirement age. But Jones has resisted living that far from hospitals and civilization.
He has diabetes, and hes a big man, Jones said. If something happened to him, I couldnt even get him to the car.
If youll only get a few years of use out of a place, its often better to rent than to buy, financial planners agree.
Consider all the costs Second homes typically come with all the expenses associated with first homes, plus a few. In addition to mortgage, taxes, maintenance, repairs and utility bills, you may face extra fees for boat storage, golf course use or upkeep of private roads.
Then theres insurance. Insurers often balk at covering remote properties or those on beaches where hurricanes are a concern. You may wind up getting fire or windstorm protection from a high-risk pool, which means limited coverage and expensive premiums.
Know what you can afford This seems obvious, but emotion often trumps common sense. You need significant disposable income to pay for two houses. The average second-home buyer, in fact, has an annual income of $85,900, according to the NAR.
Make sure your other bases are covered before you start shopping. Are your credit cards paid off? Do you have an emergency fund equal to six months expenses? (Remember, youll need more cash to deal with maintenance and repairs on another property.) Are you contributing enough to your retirement accounts and your childrens college funds?
Factor in the tax breaks Mortgage interest and property taxes on second homes are typically deductible. The write-offs are limited to two homes, however. Own any more, and Uncle Sam wont help you pay for them.
Another potential tax break: You dont have to pay taxes on any rental income on a home if its rented for less than 15 days.
Of course, you wont be able to deduct rental expenses, either. If you rent your home for 15 days or more, youll have to declare the income, but you can deduct things like cleaning, maintenance, repairs, utilities and rental agent fees. Youll have to pro-rate your expenses to reflect your personal use of the house. IRS Publication 527 has more details. (See link at left under Related Sites.)
Dont get too far ahead of yourself Some people snatch up future retirement property decades in advance, afraid that theyll be priced out of their desired market. But theres no guarantee the place you choose will still be attractive to you when youre ready to retire.
One couples dream of retiring to Florida was shattered after Jones, their planner, insisted they actually visit the lot they had purchased years earlier.
They discovered they didnt like the people, and the area had changed, Jones said.
Buy investment property with a clear head Most people -- 78% by NARs count -- buy second homes primarily for recreational use. But a growing number of buyers say theyre also or primarily buying for investment purposes: 37% last year, compared with 20% in 1999.
If appreciation or rental value is your goal, youll need to pick property in excellent locations that have amenities with wide appeal, Levin cautioned. After all, red-hot markets can suddenly cool, and marginal properties can lose value quicker than their first-rate competition.
Youll want to be on the beach, he said, not near the beach.
Expect lenders to demand larger down payments for investment property and to charge higher interest rates -- typically about 1 percentage point higher than they would charge on a residential mortgage.
Beware of time shares A time share is not an investment, no matter what the sales rep says. The only happy time-share owners Ive met are those who bought for pennies on the dollar from the poor saps who paid big bucks for them originally.
This is an industry renowned for high-pressure sales tactics and unhappy buyers. Steep ongoing fees and limited availability can quickly turn the most ideal-sounding time share into an albatross.
If youre convinced a time share is the right choice for you, shop the resale market. Youll find ads online and in newspaper real estate classifieds.
Approach joint ownership with cautionMany people who dont feel they can afford a second home on their own decide to split the purchase with relatives or friends. And many of them regret it.
Its not just scheduling conflicts that cause problems. People who are compatible in every other way can have screamingly different ideas about how often the lake house needs painting or who should be responsible for the pipes that burst last winter. I know one such partnership that finally broke up over an argument about toilet paper. (One of the parties was accused of never supplying any and frequently using the very last sheet. Shudder.)
Make sure you have an exit strategyDont just dump your second home back on the market when youre ready to sell. Consider some alternatives first.
Any profit you make on a second home is subject to capital gains taxes. (The current federal maximum is 15%, plus whatever your state charges.). If your potential profit is large and moving is feasible, you might consider making your second home your primary residence for two years. That way youll escape any tax on profits of up to $250,000 per owner.
If that wont work and youre interested in another property, you could consider whats called a 1031 exchange, said Thomas Jahncke, a financial planner with Passco Real Estate Enterprises.
These exchanges, named after the IRS code that allows them, give owners of commercial or rental property the chance to swap for other, similar real estate without owing taxes on the gains. (For more, see my colleague Jeff Schneppers article, "Let Uncle Sam help fund a retirement home.")
You would need to rent out your second home for several months before selling, and then use the proceeds to buy another rental property, which you could eventually convert to personal use. You have to hire a third-party administrator skilled in 1031 exchanges to handle the transaction, since the IRS does not allow do-it-yourself procedures.
There are 5 tax classes of property:
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