Tuesday, 8 October 2019
Purchasing a vacation home to use as a getaway and rent out for extra income is an exciting endeavor. But before you can start enjoying a new property, you have to figure out how you're going to pay for it.
If you don't plan to pay cash for the vacation home you're eyeing, there are financing options available. Consider these three common methods for financing a second home.
Most people who purchase a vacation home take out a mortgage loan, according to the National Association of Realtors. The Federal Reserve Board recently lowered its federal funds rate and has signaled that it may continue to lower rates incrementally, which may contribute to more favorable mortgage loan rates.
Traditionally, mortgage loans have been positive options for purchasing second homes because all mortgage interest was tax deductible. Recent tax law changes mean that's no longer the case. However, if your vacation home meets certain conditions, you may still be able to deduct mortgage interest payments.
According to the IRS, you may be able to deduct the interest you pay to purchase a first or second home, with total mortgage values up to $750,000. So if you owe $400,000 on your primary home and you borrow $350,000 to purchase a vacation home, it's possible you could be able to deduct all the mortgage interest you pay on both homes. (If you already had a vacation home with a mortgage before Dec. 16, 2017, you may be allowed to deduct interest on a first or second home with mortgage debt up to $1 million combined.)
If you have significant equity in your primary home, you could borrow against that equity to purchase your vacation home. Many lenders will loan up to 80 percent of the equity in your home, according to Bankrate. So if your primary home is worth $500,000 and you owe $100,000, you have $400,000 in equity. You may be able to get a home equity loan worth 80 percent of your equity, which would be $320,000.
The interest on home equity loans is no longer tax-deductible in all cases, but if you spend the proceeds of a home equity loan to build, buy or improve your first or second personal residence, you can deduct the interest up to a certain limit, according to the IRS. If you're planning to deduct home equity interest on a second home purchase, talk to your tax advisor about whether and how often you can rent the property out for income and still qualify for the deduction.
If you have enough money in a 401k account to purchase your vacation home, you may be able to take a five-year loan from your 401k without penalty. If you take longer than five years to pay the loan back; however, it could be viewed as a 401k distribution, and you may have to pay taxes and a penalty for early withdrawal (unless you are over 59 ½ years old).
Self-employed people who have a Solo 401k can use the 401k to purchase a second home to be used exclusively for a rental property. But if you do that, you can't live in the home or manage or maintain it yourself; you have to hire a property manager to handle that. While you won't be able to deduct mortgage interest or depreciation, purchasing through a Solo 401k means you don't have to pay taxes on the rental income.
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Purchasing a vacation home can help you secure a special place to get away from it all, and serve as an investment property that will earn you income. But before you can start reaping the benefits, the first step is to find the perfect vacation home in the ideal location for your enjoyment and your investment.
Renting out your vacation home for extra income can turn into a lot of work. Ask yourself these four questions to decide whether to do it yourself or hire a management company.