Purchasing a beautiful villa overlooking the ocean or a cozy log cabin in the mountains takes on a whole new meaning when your purchase is a planned investment. Renting out vacation properties can be a lucrative business, but there’s a lot more to it than putting out a “for rent” sign and raking in the cash. Here are a few key things to consider before you make the leap.
Uncle Sam keeps a sharp eye out on how owners handle investment rental properties, and vacation homes are no exception. Keep the IRS rules concerning rental properties top of mind to keep the government at bay.
Here are the basics:
- If you only rent out the property for two weeks or less during the calendar year, you aren’t obligated to report the rental income. Just treat the property as a personal residence on your income tax return.
- The IRS views you as a landlord if you rent out the property for more than two weeks during any calendar year. You’ll have to report your rental income, but you’ll also be able to deduct expenses.
- If you use the home personally for more than two weeks during the year or more than 10 percent of the time it was used as a rental property, then it is also considered a personal residence. While the IRS will allow you to deduct expenses (as long as they don’t exceed the rental income), you will not be able to deduct losses.
2. Property Location
Take emotion out of the picture when you’re choosing a location to purchase vacation property. You may have wonderful memories of summers in the beach house by the shore, but that doesn’t mean it’s a profitable location for you to invest in. Ideally, you want to buy in an established area that has a strong tourist economy, stable housing market and forecasted future growth.
Also be sure to look closely at the area in terms of seasonality. An oceanfront location is sure to be a hit during the summer, but unless you’ll make all of the money you need during one season’s rental income, you’ll need to find something that has more year-round appeal. If that cabin on the lake has nearby ski resorts and spectacular fall foliage, you’ll be in much better shape financially.
3. Types of Vacation Properties
There are three basic types of vacation ownership: single-family homes, condominiums and fractional residences.
- Condominiums have a strong appeal for a lot of investors, as most of the maintenance (and sometimes even the rental process) is taken care of.
- A single-family home carries a much higher burden in terms of maintenance, but it also offers you more privacy and independence. Unless you live nearby and have unlimited amounts of time to spend at the home, it’s wise to factor in the cost of the property management company into your overall budget.
- Fractional residences allow several unrelated parties to share the risk of ownership. One of the main benefits is the ability for all owners to share the costs of maintaining the asset. This option may be worth considering if you’re not planning on using the home for personal use. Since most fractional owners hire property management companies to take care of everything, it’s a relatively hands-off tactic.
Do your homework before buying a vacation property as an investment and learn about all your options to be sure that you’re buying something that meets your financial goals and personal needs.
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