Insurance considerations for second homes
Unless you have the resources to “self-insure,” you might want to consider homeowners insurance to protect your real estate purchase. Second home insurance is a specialized policy designed to cover properties that are not your primary residence. Policies differ because a second home may have additional risks not associated with your primary residence.
Standard homeowners’ insurance for a full-time residence costs an average of $1,754 per year, but you might pay more for a second home insurance policy. For example, American Family estimates that vacation home policies are typically two to three times more expensive than home insurance for a full-time residence.[5]
The additional risks that cause second home insurance to be higher include:[6]
- Vacancy periods: Unoccupied homes are more vulnerable to theft or damage.
- Location-based risks: Coastal or mountainous properties may face specific hazards like hurricanes, floods, or wildfires.
- Higher-end property: If your second home is a luxury property, consider high-value property insurance.
- Rental use: If you rent to others, you may face additional liability concerns, such as tenant-caused damages and liability for injuries sustained by renters or their guests.
Banks will require that your second home be insured if you take out a mortgage. If you are paying cash, the insurance coverage you want, if any, is up to you. If you seek coverage, you should evaluate risks, compare providers and determine if the policy aligns with your needs and property usage.
Including a vacation home in your estate
If you buy a vacation home, consider what happens to the property after you’re gone. If a family vacation home is part of your estate, you should put the time and effort into outlining your intentions for the next generation. Your heirs should know what they’re getting and the time, effort and resources they’ll need to put into the property to keep it functioning well. You know your family’s dynamics and that not all of your heirs will have that same level of interest or involvement in the family vacation home. Thus, be mindful of this and flexible when creating your strategy.[7]
Consider working with your financial professional and estate team to determine the best way to transfer your vacation home based on your situation. Here are a few choices you may want to evaluate:[7]
- Sell the house outright or gift it to one or more of your children.
- Establish a trust in which one or more trustees are responsible for owning and maintaining the property. Using a trust involves a complex set of tax rules and regulations. Before moving forward with a trust, consider working with a professional familiar with the relevant rules and regulations.
- Form an LLC or other legal entity where your heirs will be owners and follow specific governance rules and operating agreements in how the property is used.
As financial professionals, we can offer insights into how your vacation house may contribute to your overall estate strategy.
Tax implications of owning a second home
As we mentioned before, we’re not tax specialists, but we work with people who are. We’re outlining some general information, but it’s not a replacement for real-life advice. Consult your tax, legal and accounting professionals for more specifics regarding your second home.
If your second home is a residential home, you may be able to deduct mortgage interest up to $750,000 as long as the second home is the one that secures the loan. If your mortgage on your second home originated before Dec. 16, 2017, you can deduct up to $1 million in mortgage interest. You also can deduct state and local property taxes — up to $10,000 combined for all real estate taxes between your homes.[8]
If you rent your property for 14 days or less during the year, you may not need to report this as income to the IRS.[8]
If you rent your second home for more than 14 days a year, the IRS considers it an investment property. If your second home is an investment property, you might be able to deduct mortgage interest or real estate taxes on your personal income tax return. Still, you may be able to deduct those costs against your rental business income.[8]
When you sell your second home, you must be aware that you may not receive the same capital gains tax deduction when selling your primary residence — $250,000 for single filers and $500,000 for married.[8]
Renting a vacation home
If you have gone through all the pros and cons of buying a vacation home and are leaning toward renting, this approach also has two sides. Let’s start with the positives.
Potential advantages of renting a vacation home[2]
- Little responsibility: If you choose to rent a vacation home, your only responsibility is to leave the house the same way you found it. None of the property maintenance or utilities fall onto a short-term renter to take care of, which means you can enjoy your holiday and then dump your garbage on the way out, turn out the lights and lock the door behind you.
- Variety of options: Renting vacation homes means renting a different home anywhere you go. You won’t be limited to revisiting the same place over and over. Instead, you can change locations each time you go on vacation and experiment with the type of property to see what you enjoy best – in town or out, kid-friendly or over 55, nightlife or peace and quiet, etc.
- Cost considerations: Renting a vacation home can be a more affordable way to go on various vacations in many areas. After all, you will not pay a mortgage, maintenance fees, or other charges.
Disadvantages of renting a vacation home
Anyone who has rented a vacation home knows that there are some downsides. Here are a few of them:
- Cost: In 2024, the expected average daily rate for U.S. vacation rentals is $326.[9] This number will fluctuate based on the type of home you rent. A luxury rental could be significantly higher.
- Not your space: When renting a vacation property, you live in someone else’s home. For many people, it’s never as comfortable as staying in a place you own. You may find problems with the house, it may not have all the features you are accustomed to, and you may need a learning curve to figure out how to use everything from the TV to the thermostat.[2]
- Availability: You may need to book your vacation homes well in advance during peak seasons. Chances are you want to go away at the same time of year, but others have the same idea. Availability can be problematic if you book too late or the area is extremely popular.[2]
- Inconvenient: Renting a vacation home can be a hassle. You have to choose the home, make sure it’s available when you want, and then go through the booking process with the owner, the property manager, or a third-party website. If anything accidentally breaks during your stay, you’ll also be liable to cover it. There can also be unexpected fees that drive up the price.[2]
Make your decision carefully
I’m sure you’ve gone on vacation to a terrific location and fallen in love with it. The experience might have been so wonderful that you thought about buying a home to spend more time there. That’s how the time-share industry became so popular in the 1970s and 80s — catering to impulse buyers.
However, it’s important to remember that while you might be swayed by the most enjoyable aspects of your vacation, you should consider the negative factors that owning a second home can bring. Between costs, extra work of taking care of another property, and the impact on your other travel habits, owning a vacation home can have drawbacks. You also may want to factor in how being away could impact your relationships back home.
Before you commit to buying a vacation property, you might want to consider living there for a month or two first. Spending an extended amount of time in a rental property at your intended vacation home location may provide you with a more realistic view of the area.
There is no right or wrong answer on whether to buy or rent a vacation home. Please take the time to weigh the pros and cons thoroughly before deciding. Please do not hesitate to contact us if we can help or just be an impartial sounding board.
