MANY OF US DREAM of owning a second home near the sea, a lake or the mountains. For my wife and me, that dream location was the southern New Jersey Shore. We’d both spent many vacations there as children and then did the same with our own growing family. We had visions of taking grandkids to the beach and boardwalk.
In March 2012, we realized our dream by purchasing a three-bedroom condo in Ocean City, N.J. We rented out the condo for eight summers and used it ourselves for the other nine months of the year. Last September, we were presented with the opportunity to purchase a larger, four-bedroom condo on the same block, so we sold the original condo and purchased the larger place. We don’t plan to rent out the new place because we’re approaching retirement and hope to use it ourselves for a decent chunk of each year.
What did we learn from owning that first vacation home? If you’re tempted to buy a second home for both rental and personal use, here are my five recommendations:
1. Know the market. When we bought the property, it already had about half the summer weeks rented, so we kept the rates the same from the previous year. When I looked into it, I realized the rates had not been adjusted for seven years. I started to research similar properties in the area. I noticed two things: Our peak rate was lower than comparable properties and the period of peak rates was shorter than nearby rentals. In our area, the rates typically start low in June, grow to a peak in July and start to drop again in August. Over the next few years, we increased all of our weekly rates and stretched the peak season further into August.
2. Find a good management company. This is important if you don’t live close enough to take care of maintenance, cleaning and welcoming the next renters. In our area, realtors have historically played that role for a 12% commission. The benefit of a local presence is important in finding local services, like handymen and house cleaning. We used the realtors that we bought the house from and they were great. We also used them to sell the house.
Online services like Airbnb and VRBO are becoming more prevalent, but you’re on your own when the faucet leaks or, say, the air conditioning breaks on the hottest day of the summer—which happened our first summer.
3. Don’t expect to get rich. Vacation homes are often in high price markets. Your rental income will cover some of your costs, but probably not all of them, unless you’re in an area where you can rent for much of the year.
Meanwhile, in our area, overall home prices seemed to rise faster than rental rates—especially during the real estate bubble years. Rising prices also reflect extensive remodeling: There’s a strong trend toward knocking down older homes and building larger, more modern houses. The newer homes appear to command about a 20% premium over homes only 15 years older. We sold our home after seven years for about 10% more than we paid. That wasn’t a great increase, but it sold in two days without having to list it or show it, so our selling costs—and headaches—were minimal.
4. Think carefully about improvements. When a vacation home is both a rental and for personal use, there’s an inherent struggle between improvements necessary to rent the home and those which make it more enjoyable for your family. An over-improved home won’t necessarily fetch a significantly higher rent than the local market will bear.
The previous owner had done nothing to improve the house, but had still managed to fully rent it every year. We tried to strike a balance. We painted, and bought new furniture, electronics and appliances. It made it a much nicer place for us and our family, and we got lots of compliments from the renters, including many who continued renting for years. But it did nothing to raise the eventual sale price. This is not necessarily bad: You just need to recognize why you’re making the improvements and be comfortable with it.
5. Keep good records. Treating your vacation property as a second home—part rental property and part personal use, as opposed to a pure investment property—complicates the finances and taxation of the property. You get some of the tax benefits of owning a rental property, but not all. You must divide your expenses between rental use and personal use.
Detailed records are critical come tax time. I built spreadsheets to capture rental income, expenses and utilities, and kept a calendar of rental, personal and maintenance days. I tweaked the expense spreadsheet to match the categories used on Schedule E to report expenses. I used the same spreadsheets each year, which made it easy at tax time.
All this may sound complicated. But if you’re comfortable with finance and taxes, it’s very doable. I upgraded my tax software to a version that made it easier to handle rental properties. That said, in the year you sell, I recommend hiring a good tax preparer. For instance, the “depreciation recapture” caught me off guard and added a significant amount to our 2019 tax bill.
One final tip: A potentially valuable quirk of the tax code is the 14-day rule. This is a special rule if you use a vacation home as a residence and rent it for less than 15 days. In this case, you don’t report any of the rental income, but you also don’t deduct any rental expenses. Think of a second home in Pebble Beach, California, or Augusta, Georgia. You could rent it out for the annual golf tournament at top dollar and not have to declare any of the rental income. People in our area rent out their shore homes for two of the peak summer weeks—and they make enough to cover their homeowner’s insurance and real estate taxes.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include Don’t Leave a Mess, Treasure Hunting and Taking the Hit. Follow Rick on Twitter @RConnor609.