Vacation Real Estate: More Than a Getaway Destination
A survey conducted in 2018 by the National Association of Realtors (NAR) found that 72% of vacation property buyers and 71% of investment property buyers believe that now is a good time to buy. While a vacation home can be a treasured retreat from the demands of modern life, it can also be a smart long-term investment that offers asset diversification and potential tax benefits.
The Housing Market in 2019
According to the leading measure of U.S. home prices—S&P CoreLogic Case-Shiller Indices—homes are continuing to appreciate, but the rate of appreciation continues to slow. Data released on June 25, 2019 showed a 3.5% annual year-over-year gain nationwide in April 2019, down from 3.7% the previous month. At the same time, 30-year fixed mortgage rates remain low at under 4% after bouncing up to around 5% in late 2018.
Corroborating these trends, the National Association of Realtors expects median home prices to increase roughly 3% in 2019 and home sales to increase at a slow 1% over the previous year. Some experts suggest that these and other metrics point toward a return to long-term industry averages after a decade of recovering from the Great Recession. For vacation-home buyers, slowing price increases coupled with historically low mortgage rates may indicate that now is indeed a good time to make a move.
The Second Time Around
Although viewed by many as a luxury purchase, buying a vacation home is a major financial decision that requires special considerations. As a starting point, you’ll need to identify your short- and long-term goals. That’s because a vacation property can fulfill several different goals simultaneously – or over time. A vacation home can be:
- A cherished family retreat to be enjoyed and passed down through the generations. Or viewed from a capital appreciation standpoint, a vacation home could also make a relatively safe, long-term investment that enhances a family’s net worth.
- A retirement destination. For retirees or those starting to plan for retirement, a vacation property could one day become a primary residence. And because it’s also an investment that can be sold outright when the time comes, it could also provide a financial boost to your retirement nest egg.
- A source of current income. One study by Savills and HomeAway confirms that roughly two-thirds of second-home owners rent out their properties for income – a trend that has been growing for the past decade.
It’s difficult to ignore the impact that online vacation rental platforms have had on the vacation property rental business. Airbnb currently boasts 150 million users and six million listings in 191 countries, and vbro.com, a subsidiary of Homeaway.com, lists two million properties in 190 countries.
But estimating how much income a homeowner could potentially generate on a regular basis is next to impossible – and dependent on many variables: your location and seasonal appeal, competition in your area, your tax liability, the condition and amenities of your property, whether you self-manage or hire a management company to care for the maintenance and upkeep of the property. In short, there is a lot to navigate. That’s why it’s best to proceed with caution and do your homework before jumping into the online property rental business.
Special Tax Benefits
If you find yourself in a property selling-buying loop, be sure you make the most of a significant tax benefit. The federal capital gains exclusion, which was enacted more than 20 years ago, can be a boon for individuals or couples who own appreciated residential property. The provision allows you to exclude from your income capital gains on the sale of your primary residence up to $250,000 for singles or $500,000 for married couples.
The basic rule is simple: You must have owned and used the home as your primary residence for at least two years out of the five-year period ending on the date of the sale. For married couples, the full $500,000 exclusion is available if one of you satisfies the ownership test and both of you satisfy the use test (i.e., the property was your primary residence for the required time).
Let’s put this rule to work in the following hypothetical example.
Mr. and Mrs. Smith own two homes, one in Denver, Colorado, and one in Palm Springs, California. They sell their Denver home for $750,000 and realize a $500,000 tax-free gain for the sale. They move into the Palm Springs vacation home, assume residence for the requisite two years, and then sell the property for $900,000 realizing another $500,000 gain.
Sounds easy, right? Keep in mind that although this tax rule can be exercised every two years for federal tax purposes, individual state tax laws governing such transactions are complex, differ by state, and require detailed documentation. For these reasons, it is always a good idea to seek expert tax advice before entering into complicated, high stakes real estate transactions.
While vacation real estate does not take the place of traditional asset classes such as stocks and bonds, with proper planning it can provide affluent investors with wealth enhancement possibilities as well as many years of family pleasure.
For assistance evaluating how best to use a vacation home in your investment plan, speak with your Fifth Third wealth manager.
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