By Peter Mastrantuono
Owning a vacation home to retreat to or provide rental income remains part of the American Dream. But, it can prove to be a costly one, which without proper appreciation of its hidden expenses can quickly unravel an owner’s personal finances.
If you are considering buying a second home, you should keep in mind some obvious, and not so obvious, costs that will impact your savings and cash flow, including:
Home Purchase: You should consider how much of your net worth you want tied to a vacation property. Whether you pay all cash—a big hit to liquid assets—or take out a mortgage—a long-term claim on monthly cash flow—you need to be comfortable with this large financial outlay.
Start-up Costs: New homes need filling. You will need to furnish your new home, stock it with a wide range of household items and supplies, install a security system and buy the toys (e.g., jet ski, snowmobile, etc.) necessary to enjoy your piece of paradise.
Taxes: Taxes can become quite complicated as it relates to second homes, depending upon whether you plan to rent it or not, and for how long you do rent it. For instance, if you plan on renting it for more than 14 days, say to offset ownership expenses, the rent generally becomes taxable income. And, if you’re a retiree, additional income may mean higher taxes or premiums associated with your Social Security and Medicare benefits. Moreover, if you do rent your vacation home, lodging taxes may be due to local government.
Of course, regardless of whether you rent the home or not, there are property taxes to be paid, and you should determine what they are before any purchase.
Changes in the mortgage interest deduction may add to the cost of buying a second home, depending on your other outstanding mortgage.
Suffice it to say, taxes related to second homes are complicated, and engaging a tax professional to gain a more accurate idea of the amount of taxes you could be paying is highly advisable.
Management and Maintenance Costs: By definition, a vacation home is a home in which you may spend only a small part of the year living in. The caring and maintenance of a home, sadly, never takes a vacation. Lawns need to be cut and storm damage needs repair. If you plan on renting out your home, those maintenance responsibilities, especially home cleaning, are likely to be greater and add to your expenses. Many owners hire a property manager to care for their property and manage the rental activities. If you plan on taking this route, you should investigate property management rates in the area of your vacation home.
Insurance: You will need to insure your vacation home, the cost of which will vary depending upon the value of the home and its location. However, if you plan on renting it, you will need to obtain additional, specialized insurance, which will drive insurance costs higher.
Home Owners Association Fees: Your vacation property may be subject to condominium charges or HOA fees, including membership fees.
The costs of a buying and maintaining a vacation home may seem daunting, but by working up a budget and sitting down with a financial advisor, you may find this particular American Dream is within reach.
Peter Mastrantuono is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.