CHICAGO (Reuters) - Dreaming of a beach house? You might want to think twice about that, given tax changes that just kicked in will make owning a vacation home more costly and may tank the resale value of the second-home market.
Prices could drop about 10 percent in some markets, said Zillow (www.zillow.com) economist Aaron Terrazas, with pricey coastal areas the most vulnerable. This will not be good news for owners in popular areas who have already been waiting a decade for prices to recover the value lost during the housing crash and recession.
After the 2006 housing peak, prices dropped more than 50 percent in many popular vacation areas, and remain far off those highs. Zillow data indicates homes in Fort Myers, Florida remain 24 percent below the pre-crash peak, and Ocean City, New Jersey is still down 19 percent despite the draw of beach communities. Overall, purchases have been declining for three years.
Researchers from Gallup Inc to the Urban Institute have traced slower home buying to multiple factors – from difficulty getting mortgages to the uncertainty that an expensive investment would appreciate enough to make a purchase worthwhile.
The new tax rules will have a big impact because many second-home buyers are middle-income households, not the super rich, and even a shift of a few thousand dollars can greatly affect affordability. The median buyer’s household income in 2016 was $89,900, and only 34 percent of buyers had household incomes over $100,000, according to the National Association of Realtors (NAR). Almost three-quarters used mortgage financing.
While second homeowners can still deduct the interest on new mortgages up to $750,000, experts predict that many people will no longer itemize their expenses on Schedule A. The new tax rules raise the standard deduction to $24,000 for a married couple, and this may be too high a threshold for many people to reach without being able to claim more than $10,000 in combined property and other state and local taxes.
Also, homeowners can no longer deduct interest on home equity loans. That is likely to hold back vacation home buying because many people use home equity on their main residence to purchase additional homes, said Zillow’s Terrazas.
When homeowners think about the long-term impact on their finances, the math becomes even trickier. People are looking at vacation homes as longer-term commitments than in the past, with the average buyer planning to own the home nine years compared with five years in 2015, NAR reported.
As baby boomers think about future retirement, some are buying vacation properties while still working and use them occasionally as a retreat. Eventually, 18 percent plan to turn those second homes into homes for retirement.
The only way to afford this in the future may be to become a landlord.
If an individual turns their vacation home into a rental property and uses a business tax structure such as a limited liability company or C Corporation, they will be able to deduct mortgage interest and property taxes as a business expense, said Cliff Johnson, co-founder of Vacasa, which manages vacation homes.
Such an approach is not for everyone, however, and generally requires attention to tax details. For one thing, when you decide to sell the property as a business you may have to pay more in capital gains taxes if the home has appreciated in value, said Alison Flores, researcher for the H&R Block Tax Institute.
Some individuals could get around this making the property qualify as a private residence again by moving back in prior to the sale.
Owners can still use their vacation home for personal use and rent it out, if they keep records of the usage. Expenses can be deducted, but income is also taxable if you rent out a home for more than 14 days.
Then there is the hassle factor, which can be hard to calculate. According to NAR research, 15 percent of people who tried renting out their vacation homes decided they would not do it again.
“People might have bought the property to relax,” said Vacasa’s Johnson. “But one or two years later they may realize they never relaxed.”
Editing by Beth Pinsker and Andrew Hay