6 min read
Should You Own A Vacation Home In Retirement?
By: Kyle Walters - The Personal CFO on Aug 25, 2022 1:14:17 PM
Retirement is full of wonderful possibilities, including the ability to spend part of the year living in one place and part of the year enjoying another. Maybe you would like to spend summer someplace cooler and winters someplace warmer. Or, perhaps you love where you live but would like to be closer to your family for a couple of extra months each year. The idea of owning a vacation home seems like the perfect solution.
Owning a vacation home is a common dream for many retirees. Still, there are significant costs to consider before purchasing a second property (especially in today's market, when prices are significantly elevated).
So before you call up your favorite realtor and start picking out the second set of dishes, consider the pros and cons of owning a vacation home in retirement.
The Pros of Owning a Vacation Home in Retirement
There are always two sides to every story, but to keep things on the brighter side, let's start with the good news.
A Second Property Could Provide Income
Who wouldn't like a little extra income in retirement? After all, it's likely your retirement plan involves drawing income from your assets, so adding some income to the mix could help reduce your withdrawal rate and extend the life of your portfolio.
The way to turn your vacation home into an income earner would be to rent it out when you are not using it. Keep in mind, though, that renting is not always as easy as it sounds. As the property owner, you are responsible for ongoing maintenance, taxes, and issues that arise with the tenants. This can be especially tedious if you don't live in close geographical proximity to the property. Yes, hiring a property manager can help solve these problems, but they charge a fee, typically somewhere in the 10-15% range of rent income earned.
Also, remember that the IRS has rules about owning second residential properties, including what you can deduct in expenses on your taxes. You'll have to be diligent about dividing personal and rental expenses, and the number of expenses you can deduct may be limited if you consider the dwelling a second home. Rules vary by state regarding domicile and time limitations, so you'll want to check with the states you're living in before making any major decisions.
Vacation Homes As A Special Legacy for Heirs
Family vacation homes are a great place for you to create memories with your family, and they can also serve as a unique legacy for your heirs once you pass. Your children may find that owning and maintaining the home in your absence is a way for them to feel still connected to you and the sense of family that you fostered in that home together.
Or, if maintaining and keeping the property isn't financially feasible for your heirs, it could be a great asset to pass on in your estate. It helps to diversify the way you bequeath your wealth and can also help with the tax burden your heirs could incur upon inheriting your other assets.
The Cons of Buying a Vacation Home in Retirement
Not to rain on your parade, but it isn't all as easy as it sounds. There are some downsides to consider when deciding if a vacation home is right for you.
Rent is Not Guaranteed
There is no guarantee that you will be able to rent the property for as long or as much as you anticipate, especially if the market circumstances suddenly make renting unfavorable.
Retirees also commonly want to use their vacation homes when renting in those locations is most desirable. To say it another way, when you want to use it, so does everyone else.
It might be difficult for you to find renters who want to come in the other months. This could reduce the total income you earn and significantly decrease the merits of owning the vacation property rather than going with a VRBO or Airbnb situation yourself.
Or perhaps you have your heart set on Aspen, and you know that you'll be able to spend summers in the mountains, and more than likely be able to fill the winter months with vacationers looking to hit the slopes. Great! But the real estate markets in these areas are keenly aware of this, and the prices reflect this popularity.
Owning a Second Property Could Mean Living on Less or Retiring Later
Owning a second home increases your cost of living, which means you will need more money each month to retire. You may have to adjust your lifestyle to afford the second home (or work longer before you retire to put more money away). Not many retirees consider this possibility until it's too late, and the potential of purchasing a vacation home introduces too much risk into their financial retirement plan.
Getting a Loan Could Be Difficult
Getting a loan in retirement isn't as simple as getting one when you earn a steady paycheck. Can you still qualify for a mortgage? Yes. But it works a little differently, and it could cost you more than it would if you were buying a primary residence.
You see, the way lenders calculate your loan terms will depend on the type of income you receive and your debt-to-income (DTI) ratio. You will have to demonstrate that you have a dependable and predictable income. This includes proving all your sources of income, including Social Security, pensions, benefits, retirement account income, brokerage accounts, and any other assets you may own that contribute to your income.
Capital Gains are Different on Vacation Homes
Second homes are treated as investment properties, which means it is considered a capital asset for tax purposes. Any gains or losses will be considered under capital gains when you sell the property. This is not so much a problem unless your property exponentially grows in value from the purchase date to the sale date. On the other hand, if the property loses value, you can use the losses on the property to offset other capital gains liabilities (from your portfolio, for example).
Still On the Fence?
I don't blame you. The advantages of owning a vacation home are plentiful. You have another "place to call home," complete with all your furnishings and household items, a location where you'll likely meet and maintain friends over the years, and a sense of familiarity in a geographic spot where you enjoy spending your time. But making that dream a reality can take a little leg work. And it should involve weighing the relative merits of owning versus renting year after year.
There is no "right" answer, only what works best for you and your needs.
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