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Vacation home: rent or own?

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August 22nd, 2014

Once you retire and have more time for travel, you might set your sights on a property in your favorite destination. Choosing a sunny spot is easy, but deciding whether to buy or rent your vacation home is a little more complex.

If you have a sizable nest egg, purchasing a second home could make financial sense, especially if you anticipate that you’ll be able to generate income by renting it when you’re not there. Indiana financial advisor Warren Ward (warrenwardassociates.com) says to buy when prices are low—not when an area has already become very popular—and when you plan to own the home for many years.

“Someone who buys when everyone’s talking about it, especially if they entertain the idea of flipping it in short order, is not likely to be pleased with the outcome,” Ward says. 

Even if the town where you want to purchase a vacation home has a robust rental market, Ward says to consider all of the costs you’ll incur to lease your property to vacationers. He says sites like VRBO.com make renting vacation homes easier, but you’ll still need to pay for things like cleaning between tenants, maintenance, and unexpected repairs like water leaks. 

Bottom line: If you’re counting on rental income to afford a second mortgage, you’re better off renting yourself and leaving the hassles of maintenance and management to someone else.

‘Opportunity cost’

Ward also advises retirees to consider the “opportunity cost” of having money tied up in a second mortgage.

“If you are buying a vacation place, you are spending money that could be invested elsewhere,” Ward says. “Could it be better invested in something else? Something that doesn’t require maintenance, something that might throw off enough income to pay for a seasonal rental?”

When crunching the numbers to decide whether to rent or buy a vacation home, Virginia finance and real estate professor Bennie Waller (benniewaller.com) says you can count on all of the same expenses you incur at your primary residence—and then some. Waller says one expense people tend to underestimate when purchasing a vacation property is homeowner and association fees, which can be high at resort-type communities that are attractive to many retirees. 

“I have seen instances where homeowner fees are as high as the mortgage,” Waller says. “Every homeowner should have a voice in the association, but typically the ones who live there year-round control it.”

Rob O’Dell (wheatonwealth.com), a financial advisor with offices in the Chicago area and Naples, Fla., says he advises his clients who are purchasing homes in Florida to downsize to rentals in their home states. In addition to increasing overall expenses, O’Dell says owning two homes in retirement can have significant estate tax implications. He says homeowners can currently exclude $250,000 of proceeds from the sale of a primary residence from capital gains tax. However, if you spend more time at your vacation property than in your home state, you might get hit with capital gains tax when you eventually sell your first house.

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