Should Retirees Buy Vacation Homes?

Should Retirees Buy Vacation Homes?

Having a vacation home sounds like a great idea. After all, it’s an investment in real estate and it could be passed along to the next generation. The family could manage it as a rental property, too, generating income when the owners aren’t able to enjoy it. However, there are some things to be careful of, warns Barron’s in the article “What Retirees Should Know Before Buying a Vacation Home.”

Taxes, maintenance, insurance and the possible cost of hiring a rental-management company are just a few things to consider when looking at your budget. Above all, don’t think of it as an investment. This is because, with real estate, there are no guarantees. For one thing, it’s one of the most non-liquid assets you can hold. You can’t count on selling it for a good price whenever you need some ready cash.

The first and most important question: can you afford it? Retirees are usually living on a fixed income. The cost of a vacation home can be loaded with surprises, just like any other property. If there’s enough of a nest egg to live on and there won’t ever be a need to sell fast, then it may be a good move.

If there’s enough money to purchase the home, then investing in someone to manage the property is a good idea. Empty homes are targets for thieves, and if there’s a maintenance issue, an uninhabited home is vulnerable to damages.

Where taxes are concerned, the sale of a second home does not give the seller the same capital gains tax exemption as the sale of a primary residence. That exemption is only available for people who have lived in the home as a primary residence for at least two of the previous five years. The exemption is up to $500,000 for married couples.

There is one way around it, if it makes sense for owners. Let’s say that they plan on downsizing from their primary residence. They sell it and use the tax exemption. They then move to the vacation home, for at least two years, using that as their primary residence. At that point, they can sell the home that has now become a primary residence, enjoy the generous tax exemption, and then move to a new primary residence.

As a rental property, owners are permitted to rent for up to 14 days total without owing any taxes on the rental income. After the 14-day period, taxes must be paid, but some of the rental expenses are tax-deductible. Because of this, it is important that you keep good records of anything related to a vacation home.

If the intent is to keep the house for as long as the owners are living, it becomes part of the estate and must be included in an estate plan. Leaving it to the next generation may be feasible if all of the children want to keep the house and can afford its upkeep. Have a conversation with the children first. Giving the house to children can be accomplished by putting it into a limited liability corporation with an operating agreement that defines it. Each child will have a stake in the entity that owns the home, rather than the house itself.

Talk with your estate planning lawyer about how the purchase and inheritance of a vacation home may impact your overall estate plan before making a purchase.

Reference: Barron’s (Jan. 18, 2020) “What Retirees Should Know Before Buying a Vacation Home”