Whether you dream of hosting friends and family at a lake house property or living the snowbird lifestyle of escaping the cold winter months, here are five things you need to know prior to buying a second home.

1) Purpose of Your Second Home

The first thing to decide is whether your second home will be a Vacation Home or Investment Property. Some second homes are a combination of both.

Vacation Home – A second home you live in during part of the year, purchased for personal use/enjoyment.

Investment Property – Real Estate purchased with the goal of generating income.

For the IRS to consider your second home a personal residence, you need to use the home for more than 14 days, or 10% of the days that you rent it out, whichever is greater. For example, if you rent out the house for 26 weeks (182 days), you would need to use the home for more than 18 days throughout the year.

How you plan to use your additional property will have implications on taxes and financing.

2) Second Home Mortgage Considerations

A second home loan differs from that used for a primary home or investment property, mostly because each property type represents a different level of risk to the lender.

There are several underwriting requirements including: single-unit property (such as single-family house, condo, or townhouse), not professionally managed, and must be at least 50 miles from your primary residence.

Lender qualifications for a second home loan may include having a higher down payment, credit score, and debt-to-income ratio. According to themortgagereports.com, unlike investment properties, you cannot use future rental income for your debt-to-income ratio.

3) How Your Second Home May Impact Your Taxes

If your vacation home will be used for personal use only, you can deduct the same expenses as with your primary residence: property taxes and mortgage interest. Mortgage interest up to $750,000 can be deducted if you are single or married filing jointly. (IRS) You may also be able to deduct home office expenses if you meet the criteria. (Turbo Tax)

Property tax varies widely by state and can be another important factor in determining where you want to purchase your second home. According to the Tax Foundation, Illinois has the second highest effective rate on owner-occupied property at 2.05 percent. Contrast that to popular snowbird states like Florida at 0.91% and Arizona at 0.65% and you can see how the financial implication of “location, location, location” can be a big one.

4) Impact to estate plan

There are several considerations that go into how to title and structure the ownership of your second home. If you want to pass along the property to loved ones, make sure you’re asking this question. Can your beneficiaries afford to maintain the property in the future, including taxes and maintenance expenses? If the answer is yes, here are some options to discuss with your estate planning team.

Gift a portion of the property each year. In 2024, the federal annual gift tax exemption is $18,000 (for married couples it is $18,000 each, for a total of $36,000). Parents can gift portions of their property up to the federal annual limit over a number of years. If the parents pass on before the entire property is gifted, the rest is included in the taxable estate.
Place your second home in a revocable trust. This allows you to name your beneficiaries but retain full control. Upon death, the living trust automatically converts to an irrevocable trust.
Establish a Qualified Personal Residence Trust (QPRT). One of the biggest benefits of a QPRT is that it effectively removes the value of your second home and all future appreciation from your taxable estate. A QPRT is irrevocable, which means it cannot be amended and all decisions about the property will be made by a designated trustee who will need to be outside the immediate family.

Remember, property left to someone in a will must go through probate, a lengthy legal process, and may face estate taxes.

5) Make sure you have good medical care in both locations.

It’s important to make sure you have the best possible medical care close to home. This is often an overlooked consideration when dreaming of living in a remote location at the lake or on the beach. It is especially critical if you have a medical condition that requires ongoing attention.

The good news is, if you are 65 and older and enrolled in original Medicare, you will be covered in any state. If you are not 65 yet or if you are covered by individual health insurance, be sure to review the terms of your coverage and types of costs you might incur while you’re away at your second home. Most insurance plans have in-network coverage that varies from emergency care. This is also an important consideration for friends and family coming to visit.

Owning a second home can offer many valuable benefits including an enjoyable retirement lifestyle, a sound financial strategy, and a destination for friends and family to make a lifetime of memories. Before purchasing your second home, please contact me, or your Clearwater Capital Advisor to discuss the impact of this asset to your overall financial plan.

Sources:

https://themortgagereports.com/21116/second-home-mortgage-qualify-for-vacation-residence

https://blog.turbotax.intuit.com/tax-deductions-and-credits-2/home/how-does-your-vacation-home-affect-your-taxes-23418/

https://www.irs.gov/publications/p936

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