5 Tax Tips for Buying a Second Home
Keep these costs in mind to minimize the blow to your bank account.
A vacation home has been a lifelong goal of yours, and you’re finally in the financial position to invest in that beach house, ski chalet or international getaway you’ve been dreaming of.
But hold on – you’ve thought about the costs that occur after you purchase the property, too, right? Before you jump into a second home purchase, be sure to factor in ongoing expenses such as maintenance, travel to and from the destination and property taxes.
“Homeowners should be thinking about the overall impact of what the move’s going to do to them,” says Jonathan Mariner, founder and president of TaxDay, an app that helps users manage and prepare tax information.
Here are five tips to help you navigate the tax-related expenses of purchasing a second home.
[See: The Best Apps for House Hunting.]
Tax rates vary based on where you buy. It’s a given that certain states and municipalities charge a higher tax rate than others, so before you purchase a vacation spot in a swanky mountain town, investigate how much you’ll have to pay annually in property taxes.
In Park City, Utah, for example, people who own a secondary home in the popular ski destination pay roughly twice what full-time residents pay – 1 percent of the property’s value annually.
While locally the tax hit for owning a vacation home may seem high, some individuals purchasing those vacation homes see the tax rate as low compared to where they live year-round, says Ben Fisher, a Realtor for Summit Sotheby’s International Realty in Park City. “Most people are in New York or California, where they have pretty high tax rates,” he says.
The states with the lowest effective real-estate tax rate in 2016 were Hawaii (0.28 percent), Alabama (0.43 percent), Louisiana (0.48 percent) and Delaware (0.53 percent), according to WalletHub, which calculated the rates by dividing the median real-estate tax payment by the median home price in each state. The same list showed the states with the highest effective real-estate tax rate are New Jersey (2.29 percent), Illinois (2.25 percent), New Hampshire (2.1 percent) and Wisconsin (1.97 percent).
If you’re purchasing outside the country, rather than paying significant real estate taxes you might instead pay a one-time fee. Nuri Katz, president of Apex Capital Partners, a boutique investment advisory that regularly assists individuals investing in property abroad, says many Caribbean islands require a one-time stamp tax that varies based on the other types of taxes each country charges, with small annual property tax rates of around 0.1 percent.
You might be able to deduct your mortgage interest. Federal tax rules allow for deduction of mortgage interest paid on two residences, allowing you to deduct interest for your primary residence and vacation home at the same time.
“If you’re buying a second home and you’re going to finance it, you can deduct the interest on it for federal tax purposes,” Mariner explains. “And most states will tend to follow the federal rule … but it’s only up to $1 million of valuation.”
Don’t forget about future tax increases. A smart real estate investment means the property’s value will rise, meaning a bigger payoff when you decide to sell. But in the meantime, don’t forget about the cost that comes with a higher-value property.
“Think about not just the impact today but the annual increase in appraised value – or assessed value – that will also affect the property tax rate,” Mariner says.
If you buy in a hot market or an area seeing a lot of development, don’t be surprised if property values increase significantly as more people purchase and demand grows. Once your property is appraised for a higher value, the amount you’re expected to pay in taxes will increase accordingly.
It’s also possible the property tax rate will increase in the future. Mariner notes that the potential for federal budget cuts under the next White House administration could lead states to search for alternative ways to make up where federal funding stops.
“States are going to be looking at how we basically pay for general services. Real estate taxes – property taxes – are a big source,” he says.
Consider the amount of time you will spend there. If you plan to spend at least half the year in your second home, it may be financially beneficial to change your primary residence.
Mariner explains that he primarily lives in Florida but also has a home in New York. As a primary resident of Florida, he benefits from the Sunshine State’s homestead exemption, which includes a deduction in the home's appraised value and a limit to how much property taxes can increase based on valuation from year to year.
To be a primary resident in Florida, however, Mariner has to provide proof that he lives there at least 183 days out of the year. “There are a lot of states that will look at other circumstances that might determine if you are a resident,” Mariner says.
If you’re purchasing a second home outside the country and plan to spend most of your time there, becoming a citizen in your new country may be a good option. In many of the small countries in the Caribbean, for example, you can gain citizenship “based on the purchase of real estate,” Katz says.
Don’t forget other fees. Be sure you don’t overlook additional costs before you purchase your secondary home.
If you’re buying a vacation home in the Caribbean, for example, Katz says there are costs like an alien landholders license, which is 10 percent of a property’s purchase price in Dominica. In addition, lawyer’s fees in the Caribbean are a percentage of the purchase price (typically about 2 percent), rather than an hourly rate as they are in the U.S.
And wherever you live, you should be concerned about how your home will be cared for while you’re not there. Can you shutter the home well enough to avoid weather-related property damage?
Katz says there’s a property near his home in Antigua that sits vacant while the owner lives in the U.S. “While they’re not here, they don’t really have anybody taking care of the property, so there’s a cat family living on the property now,” Katz says.
You may need to pay an individual or management company to ensure your property stays in good shape while you’re away, or hire someone to handle rentals if you wish to turn your vacation home into an income property. For rental units, it's common for property managers to charge around 10 percent of the residence's monthly rental value, but costs can vary based on where you're located, whether you hire a company or individual to care for the home, if the property is vacant while you're away and what work may be required.
“You have to have somebody really taking care of the property as if it’s their own,” Katz says.