Buying a Vacation Home vs Investment Property

When you are deciding whether to buy a vacation home or an investment property, your available capital as well as your lifestyle needs are key considerations to making the choice that sets you up for a successful purchase.

Before any major purchase, especially that of a vacation home, close examination of one's personal finances is the responsible way to begin. Regardless of your stage in life, you need to be able to continue to efficiently save after such a purchase. Whether it is saving for college tuition for your children or securing the nest egg for retirement, a comprehensive savings plan should be a priority. With a second home, the expenses are many and, in some cases, more than those associated with the primary home. Expenses will usually include, for example, the mortgage and interest, property taxes (which can be exorbitant if you choose a vacation home on a protected waterfront), insurance, maintenance and utilities. You may also need to pay for a property manager if you are not lucky enough to have a friendly neighbor to keep an eye on the property during extended absences.

Tax-Free Rental

For most people, the purchase of a vacation home is more for leisure and less for the investment possibilities. The potential to make a profit owning a vacation home is real but should not be the prime motivating factor. The majority of vacation homeowners make the choice to maintain their vacation homes as a personal property, as opposed to a rental investment. However, an option that many people are not aware of is the two-week tax-free rental. If you choose to maintain the property as a personal vacation home, you are still eligible to rent the property for up to two weeks tax-free, while still deducting the cost of ownership. This is not a bad way to make a little extra money, especially at the height of the vacation season if you are not available to use the home yourself.

Residential Investment

For those who are buying a property strictly for the income potential, a residential investment is the best option, given that most people know the basics about what to expect, simply because they too live in a residence. Also, the management aspect of the property is more straightforward than that of a business. However, by no means is such a venture without difficulties. Being a landlord can be a complicated role, and it is always best to confer with a real estate attorney when questions arise.

Cash Flow

Before the purchase of an investment property, the cash flow of that property should be calculated. The cash flow is based on taking the monthly rental income and then subtracting all the expenses on a monthly basis. Do not be conservative. Consider the worst case scenario and budget for it. From the rental income, subtract the monthly house loan payment, any taxes, insurance, utilities that a landlord would pay and the costs of repairs, maintenance and advertising. At least a 5 percent vacancy consideration should also be added to the calculations. If the current owner is using the property strictly for investment purposes, ask to see the Schedule E from his or her income taxes. If you purchase a rental property that produces a negative cash flow, you should know before you buy whether you can claim that loss on your personal income tax return. If you're a high income earner, you may not be able to deduct any of the rental loss, and then perhaps this would not be the best option for investment.