Family sets up for a day on the beach outside of their vacation home

Do you ever daydream about having a place where you can get away from it all? A refuge where you can relax and spend time with family? A home away from home where you can indulge in your favorite hobbies, like boating, skiing or sitting in the sand?

Investing in a vacation home can offer you your own personal slice of heaven, but you should consider a number of factors, including your budget, lifestyle and how much you plan to use it before making a purchase.

Is a vacation home considered an investment?

Any property you own can be considered an investment. That’s because home ownership can build equity.

You can think of home equity as similar to other long-term investments, such as bonds. Your money isn’t accessible in the short-term, but it has growth potential (or, in the case of real estate, appreciates in value). You can also use your equity, via a home equity loan or home equity line of credit, to fund other things.

The difference between a vacation home and rental property

As much as you might like to, you probably can’t spend all your time at your vacation home. If you choose to rent out your home, it could be considered a business for tax purposes. Understanding how your home is classified has important tax implications.

According to the IRS, your vacation home can be classified as your second residence if the number of days you use it for yourself is greater than 14 days or 10% of the days you rent the home to others at a fair market price.

Otherwise, it’s considered rental property. Here’s an example:

Second home or rental property? The amount of time you spend living in or renting your vacation home may seem like a small matter, but it can make a big difference when it comes time to file your taxes. If you rent to spring breakers from April to June but use it as a family home from July to August, it’s a second home. If it’s your go-to for an annual family and friends week, and you rent it out the rest of the year, it’s a rental property. Image of an animated beach house.

What are the tax consequences of having a vacation home?

If your second home is used as rental property, you have to pay taxes on the income it brings in. But you can write off many expenses related to maintaining the property, such as fees charged by online reservation platforms (think Airbnb), supplies, occupancy taxes, insurance premiums, utility costs, lawn care and landscaping, property management fees and mortgage interest.

If your vacation home is primarily for your personal getaway and does not fit the IRS definition of a rental property, you can deduct your mortgage insurance and property taxes in much the same way as you do for your primary residence.

Keep in mind: When you sell a vacation home, you must pay tax on the profit.

Do vacation homes appreciate?

Like any home you own, a vacation home will generally appreciate in value over time. As you pay down your mortgage, you build equity. Home ownership is one way many people build generational wealth, and a vacation home is no different. But it’s important to remember: Real estate is not a liquid asset. When you buy a vacation home — or any property — you should plan to own it for at least five years in order for it to appreciate.

Investing in a second home can be used to build a nest egg for retirement.  You’ll build equity over time, and when you retire, you might choose to sell your primary home and live in your vacation home full-time. Or you could sell the property and use the potential profit to fund your future living expenses. There’s no guarantee you’ll turn a profit, though, so relying on the sale of a vacation home is considered a riskier way to plan for retirement.

The pros and cons of short-term vacation rental investing

Before you go all-in on investing in a short-term vacation rental property, carefully consider all the advantages and disadvantages.

Pros

Owning a vacation property comes with a number of benefits, including financial perks such as potential rental income, building equity and tax incentives. It can also serve as a convenient, fun spot for you to gather with family and friends. Your vacation home could become a place cherished by generations, if you choose to leave it to your heirs.

If you buy a vacation home in an area you frequently travel to, you have a go-to place to stay without the hassle and expense involved in a vacation rental or booking other accommodations.

Cons

Investing in a vacation home is not without its drawbacks. The experience comes with significant expenses, including mortgage payments, homeowner’s insurance, repairs and maintenance and management costs. It can also require a significant time commitment if you choose to use the home as a rental property and mostly handle the management tasks yourself. You will need to list and market the property to find renters, and you’ll be responsible for handling guests’ concerns or problems, too. If you outsource these duties, you’ll rack up extra expenses.

You may find owning a vacation home ends up inhibiting your travels. That’s because you might feel compelled to get as much use out of your investment as possible, limiting your willingness to visit other destinations.

3 points to consider before investing in a vacation home

Purchasing a vacation home is a big decision. Before determining if it’s right for you, here are three considerations:

1. Stage of life

Are you busy raising young children and advancing your career? Or are you retired or soon to be retired? Your lifestyle and current obligations should be a major factor in your decision. Consider if you’re able to utilize the property enough to justify the investment if you’re planning to mostly use it for personal use. Similarly, do you have the time and resources to manage renting the property?

2. Finances

Whether you plan to use it primarily as your personal vacation home or rent it out, a significant financial investment is required. Can your budget and other financial responsibilities and goals — like your primary home mortgage — accommodate a vacation home?

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3. Location

Where you buy a vacation home has a big impact on whether it turns out to be worth the money you spend on it. Is it close enough for you to visit as often as you’d like? Is renting your property allowed by the city, municipality and/or homeowners’ association where your vacation home is located? Is it in or near a popular tourist spot with a strong short-term rental market? Consider all of these questions when choosing a location for your vacation home.

Is a vacation home a wise investment?

Whether it’ll serve mostly as your personal retreat or a rental property, a vacation home can be a wise investment. Carefully weigh all the pros and cons before deciding if it’s right for your financial situation and lifestyle.

Considering purchasing your first or next vacation home for either personal or investment purposes, check out your mortgage options with Ally Home.

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