July 27 2004
BOSTON (CBS.MW) - As summer-vacation season hits full stride, many conversations at backyard barbecue's and beach get-togethers turn to second homes and our growing desire to own one.
U.S. vacation-home purchases hit a record 445,000 in 2003, accounting for more than five percent of all home sales, according to the National Association of Realtors. With continued low mortgage rates and Baby Boomers in their peak-earnings years, many feel owning a second home is within reach.
Already, there are about 6.6 million vacation homes in the U.S., a figure expected to grow by 125,000 a year over the next decade.
Low interest rates and highly appreciated primary home values enabled more people to buy a second home. That's especially true for empty-nesters who sell their larger home and buy a smaller primary residence and a vacation home in the location where they intend to spend their retirement years.
Since 1997, married homeowners can exclude from taxes up to $500,000 in gains ($250,000 for singles) on the sale of a primary residence that's been owner-occupied for two of the last five years. For that reason, there's no longer an incentive to buy a larger more expensive home to rollover gains from the sale of a highly appreciated home.
And with advancements in technology and communications, more workers are able to perform their jobs even when they reside in remote locations. For example, a radio reporter can prepare and file daily reports from a vacation home on an island in the Caribbean!
Whether it makes sense to buy a second home depends largely on such factors as the costs, affordability, prospects for future appreciation and ability to generate rental income. With price appreciation of second homes rising faster over the past two years (17 percent) than for primary homes (15 percent), many homebuyers see owning a second home as a "you can't lose" proposition.
One of every three people in the NAR survey bought their second home primarily as an investment. As with all things real estate, price appreciation depends mostly on three factors: location, location and location.
Seventy one percent of vacation homeowners surveyed by NAR don't rent their home at all, while 11 percent rent for less than one month a year. I'd argue even owners should think of their vacation home as an investment, particularly given the possibility for rental income.
When selecting a location for a second home, consider a location where there's a real possibility to collect a premium rent for a limited time, such as during a seasonal rental or during a special event. That will help defray some ownership costs. Think of a second home as similar to an investment in a dividend-paying stock. An investor would never think of declining the dividend income owed on the stock, but that's just what owners of second homes do when they forgo renting their property when not in use.
One of the tax breaks for those who rent out their vacation home during the year for the lesser of 14 days or 10 percent of the days of personal use is that rental income collected for those short-term rentals is tax free.
For longer periods, rental income received must be reported on Schedule E of your income-tax return. If you use your vacation home for personal use for the greater of 14 days or 10 percent or more than the days it is rented to others at a fair rental price, then only the expenses associated with period of the rental are allowed to be deducted against the rental income.
According the NAR study, 21 percent of second-home buyers use the equity in their primary home to finance the purchase of a second home. The financial strategies include taping a home equity line of credit or a cash-out refinance of the mortgage on their primary home, which involves taking out a larger mortgage, using the borrowed funds to pay-off the smaller existing mortgage and the excess cash for the down payment or purchase of the second home.