People buy vacation properties for a variety of reasons — both rational and emotional.
For Jack Walker and his wife,1 it was a seemingly endless series of snow storms in the winter of 2015 that finally drove them to buy the seasonal home in Florida they had always talked about. “We were looking for a place that we could use to escape from the cold weather but also one that was accessible to our kids and grandkids,” he recalls. They settled on a large condo on a golf course where they also can live when they eventually retire.
According to the National Association of Realtors (NAR), more than 720,000 home buyers purchased vacation properties last year.2 Some, like Jack Walker, were looking for a place that could serve the dual purpose of providing a vacation escape and a place where family and friends could visit. Others were looking for a place where they could build roots and relationships for their future retirement. Still others were looking for both a vacation spot and an investment property.
Whatever the reason you’re seeking a second residence, how do you choose the one that’s best for your situation? “Consider the practical and emotional value of the property as well as its cost and location before you take the plunge,” says Charles Nilsen, Executive Vice President and National Director of Residential Lending at Boston Private. It’s easy to fall in love with a great property at a good price, but make sure you also consider these other factors before jumping in.
1. What’s the best location for you and your family, now and later?
Whether you’re looking for a southern escape from the bitter Northeast winter or a cool mountain retreat from the West Coast heat, think about why you’re buying the property. Is climate a big factor? How about proximity to activities and interests you enjoy, such as searching for antiques, golfing, boating, fishing, or skiing? Do you want something more remote and rustic, away from the bustle of popular resorts? Or is being close to good shopping, entertainment, and restaurants important to you?
If one of your goals is to invest in a property that brings friends and family together, as Jack Walker did, consider its distance and ease of access for the people who will be visiting you. If you eventually plan to retire to the second home, think about your proximity to healthcare services in the future and the importance of building a network of friends and supportive relationships there.
"Consider the practical and emotional value of the property as well as its cost and location before you take the plunge."
2. How will you finance it?
Depending on your financial situation, you may decide to buy or build your second home with cash and forgo another mortgage payment. But instead of dipping into your investments and taking a tax hit, there is another option: borrowing against your investments with a line of credit.
That’s what Max and Susan Lee did in 2016 when they decided to build a second home in a neighboring state near the ski resort that their family had gone to for years. “They wanted the house to be available to their extended family throughout the year and also to serve as the focal point for socializing during the holidays,” says Nilsen.
When they sold their business a few months earlier, the Lees had put the proceeds into a diversified portfolio of investments that could potentially keep their money growing throughout retirement. So when they needed money for the construction of their vacation home, they were reluctant to tap into that nest egg. “That would have meant cashing out their newly invested assets that had performed well in a rising stock market and incurring capital gains,” remembers Nilsen. Instead, they decided to pull cash out of a flexible line of credit secured by their Boston Private Wealth investment account.
“This strategy allowed them to keep their diversified assets at work while they paid the contractor. And the cost of the variable rate line of credit was more favorable than any construction loan they could secure,” he explains. Once the home was finished, they took out a conventional 15-year mortgage to pay off the credit line and lock in a low fixed rate.
They also chose to build their vacation home in a development with onsite property management so they didn’t need to worry about maintenance and potential rentals when they were not there. The management office could coordinate occasional rentals and the time set aside for family members.
"Instead of dipping into your investments and taking a tax hit, there is another option: borrowing against your investments with a line of credit."
3. Will this affect your other financial plans and priorities?
The Lees were mindful of how financing a second home might affect their retirement investments. That’s a critical consideration if you’re buying or building a vacation property. So is the effect on your cash flow if you take out a traditional mortgage.
As recent hurricanes like Irma and Harvey remind us, it’s also critically important to make sure your property is adequately protected and insured against both natural disasters and man-made ones. You’ll want to factor in the high cost of flood and storm insurance if you’re buying near the ocean or on a river and the cost (and availability) of fire insurance if you’re in a remote location that relies on a volunteer fire crew.
There also may be covenants on shoreline property that restrict how and what you can build to prevent future storm damage and beach erosion. And if you plan on renting out your property, you’ll want to check on whether your casualty insurance and personal liability limits should be higher.
If you’re thinking about purchasing a vacation property purely for its investment potential, do so with some caution, suggests Nilsen. Real estate can be a good diversification strategy because its performance is not correlated to stocks. But you also don’t want to overdo your allocation to real estate by purchasing an individual property that will be a large, illiquid asset in your investment mix.
Investing in a vacation home also means being subject to supply-and-demand pricing and interest rate fluctuations. According to the National Association of Realtors (NAR) Chief Economist Lawrence Yun, vacation sales in 2016 fell for the second consecutive year and have fallen 36% from their peak in 2014. “In several markets in the South and West, the two most popular destinations for vacation buyers, home prices have soared in recent years because substantial buyer demand from strong job growth continues to outstrip the supply of homes for sale,” he reports.3
That may be good news if you’re a seller, but not if you’re looking for a low-cost investment because there are “fewer bargain-priced properties to choose from,” notes Yun.
"As recent hurricanes like Irma and Harvey remind us, it’s also critically important to make sure your property is adequately protected and insured against both natural disasters and man-made ones."
4. Should you consider becoming a permanent resident in the new location?
As you get closer to retirement, you might think about the possibility of changing your primary residence from your current home to your vacation property, as Mary Bruno did.
Mary owned a large home on the East Coast and a luxurious condo in Naples, Florida for many years. When she initially purchased the Naples property, she had planned to retire there at some point. But in the interim, Mary made many friends, built a strong social network, and created a sense of community at her winter home.
When this spry 90-year-old finally decided to become a permanent Florida resident recently — both to slow down and to take advantage of its income tax-free status — she chose to buy into a desirable assisted living community, using the equity from the sale of her condo as part of the initial entry fee.
Because she had 15 years of winter visits to build roots in the area before her transition to full-time residency, the move was easy from a social and logistical standpoint. And her previous long-term stays in Naples helped her establish the facts and circumstances that tax authorities look at when determining if a true change in residency for tax purposes has occurred.
Knowing the rules for residency is key because the requirements can vary from state to state, says Marie DelRossi, J.D., LL.M., Managing Director and Wealth Strategist at Boston Private. “Most states use both quantitative (number of days in the state) and qualitative (facts and circumstances) ‘tests’ to determine residency/domicile for tax purposes, but the details for every state are different,” says DelRossi.
To be considered a full-time resident in a new state (i.e., change your tax domicile) you must sever “tax ties” with the jurisdiction you are leaving as wells as build “new ties” (both formal and informal) with the state in which you intend to establish residency going forward. So the legal requirements established by the state you are departing from and legal requirements related to the state you are going to must both be satisfied.
As an example, DelRossi outlines the requirements for someone changing residency from Massachusetts to Florida.
“You will be considered a statutory resident of Massachusetts if you maintain a permanent dwelling in Massachusetts and you spend more than 183 days of that particular tax year within its borders.” This is known as the Statutory Residence Test, she explains. So, to end your residency/domicile in Massachusetts you must fail the Statutory Residence Test and satisfy a “facts and circumstances” test which shows that you:
To establish your new residence/domicile in Florida you should:
All of these actions in Florida will help show Massachusetts your true intentions. “Essentially, you must make Florida your new center of gravity,” concludes DelRossi.4
"Most states use both quantitative and qualitative ‘tests’ to determine residency/domicile for tax purposes, but the details for every state are different."
5. What are the estate and legacy planning implications?
Purchasing a new vacation property also may mean making changes in both your will and your trust documents to reflect how you want the new asset to be managed at your death or incapacity. You’ll need to decide:
If your vacation home becomes your permanent residence, you’ll need to revise your will, trusts, and other estate planning documents to reflect the change, says DelRossi. This is particularly important if the new state has:
Reworking your estate planning documents shouldn’t be difficult, particularly if they are already in place in your previous state. But be careful if you have already funded a living trust in your former state, for “this could trigger income tax consequences in that state regardless of whether you are still a resident there,” cautions DelRossi. It would be best to terminate that previously funded trust and transfer the assets into a new trust established in your new state.
“If you’re purchasing a residence in a continuing care retirement community (CCRC), make sure you ask your advisor to look over the terms to understand how it could affect your cash flow and estate plan. If you’re entitled to a refund of your entry fee when you leave the CCRC, consider directing that money into a trust vs. leaving it in your general estate,” she says.
How Boston Private can help
Your Boston Private advisor can help you explore the effect of a vacation home purchase on your current investment strategy, financial priorities, and estate and legacy plans. To make sure you take advantage of all of the financing opportunities available to you as a Boston Private client, talk to your Boston Private advisor or mortgage lender.
The opinions expressed and information contained in this article are given in good faith, may be subject to change without notice, and are as of the date issued. The accuracy and completeness of this information is not guaranteed. Since each client’s situation is unique, please review your specific investment objectives, risk tolerance and liquidity needs with your advisor before a suitable investment strategy can be selected.
1 - Names in this article have been changed for privacy.
2 - National Association of Realtors (NAR) 2017 Investment and Vacation Home Buyers Survey https://www.nar.realtor/news-releases/2017/04/affordability-tight-supply-cause-vacation-home-sales-to-plummet-in-2016-investment-sales-climb-45
3 - As quoted in the National Association of Realtors’ (NAR’s) report on their 2017 Investment and Vacation Home Buyers Survey https://www.nar.realtor/news-releases/2017/04/affordability-tight-supply-cause-vacation-home-sales-to-plummet-in-2016-investment-sales-climb-45
4 - https://www.thebalance.com/how-to-become-a-florida-resident-officially-3505215
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