Buying a second home can be an exciting milestone. It can become a vacation spot to build memories year after year and a valuable financial asset. It also comes with a unique set of choices that can impact your personal finances. At Heritage, we believe in making informed decisions to grow and safeguard your wealth. In addition to lifestyle fit and ongoing maintenance costs, these factors are key aspects to consider when buying a second home:
Financing
Mortgage Options: Securing a mortgage on a second home can be more challenging (and more costly) than for a primary residence. Lenders may demand increased standards and higher interest rates as second homes can be perceived as a greater risk.
Home Equity: If you have equity in your primary home, you may want to compare a cash-out loan on that property with an acquisition loan on the new property to see which has more favorable terms. You may also consider a home equity loan or line of credit (HELOC) to finance your second home purchase.
Asset-Based Lending: We may be able to help you use brokerage account assets as collateral to secure a loan if mortgage financing is not available. This method can be administratively easier than a mortgage application but involves different features you should discuss with your Wealth Manager.
Income Tax Implications
Rental Income: Renting out the property when not in use could help cover some expenses. But keep in mind that becoming a landlord, even briefly, can also add costs and complexity. You’ll want to ensure you are adequately insured and handle taxes appropriately. You may also find you need to pay a professional third-party to manage tenants.
Deductions: Keep meticulous records of all rental income and expenses for tax purposes. You may be eligible to deduct some operating expenses if the property is rented out. Property tax and mortgage interest deductions are available even if the property is not rented out, but those have situation-specific limitations that keep many taxpayers from taking advantage. Don’t assume your tax experience will be the same as someone else with multiple properties, a variety of classifications impact deductibility.
Capital Gains: If you decide to sell your second home down the road, you may not be eligible for the same capital gain exclusions that apply when selling a primary residence. You can try to temporarily shift residency in order to capture this tax benefit but in practice this can be challenging to execute (or too disruptive to your lifestyle).
Estate Considerations
Inheritance Planning: Incorporate your second home into your estate plan. Determine how the home will be sold or passed on to heirs and the potential estate tax implications – especially if you own property in multiple states. Even if you don’t expect to owe an estate tax, you’ll likely want your family to avoid disputes plus the time and cost of probate. If the property is inside your estate at your passing, your heirs may benefit from a step-up in cost basis, allowing a sale without any realized gain.
Trusts: Placing your second home in a trust may help manage estate taxes and streamline the transfer of ownership. However, your ability to change the deed may be limited if there is a secured mortgage in your name. Consult with your lender before paying attorney’s fees or attempting any changes to the title.
Gifts: You might consider if your second home acquisition should be made as an irrevocable gift, to benefit the next generation of your family. If the home increased in value over many years, this would keep that appreciation outside of your taxable estate, potentially lowering future estate taxes. A potential downside to this approach is that the home would no longer receive a step-up in basis at your death, which could mean a taxable capital gain for your heirs if they sold it.
Risk Management
Insurance: Protect yourself with adequate liability insurance to cover potential accidents or injuries that occur on your property. You may need to include a second home in your umbrella policy to get the most coverage. If you rent out the property, you may need additional insurance. Some insurance policies reduce coverage if the home is unoccupied for extended periods. Properties in high-risk areas may be difficult to insure altogether; see Parts of America Are Becoming Uninsurable.
Legal Risks: If you rent out the property, obtain an understanding of landlord-tenant laws and have appropriate lease agreements in place.
Longevity & Accessibility: Consider if the property and location have features you can continue to use as you age. You may need to find out if any health insurance benefits change if you are outside the state of your primary residence, including Medicare.
Final Thoughts
Buying a second home is a significant financial commitment that requires careful planning. By addressing the factors outlined above, you can make a decision that aligns with your financial goals and lifestyle aspirations. At Heritage, we are here to assist you with tailored advice to ensure your decisions have confidence and clarity.
Additional Resources:
What Issues Should I Consider When Owning A Rental Property?
