By Constance Mitchell Ford
One of the biggest decisions owners of vacation homes struggle with, after deciding where to buy one, is whether to rent it out during the times when they’re away. As with all big decisions, there are pros and cons.
The cons are easy to list: Strangers in your home! Who knows what germs they’ll bring? Or what they’ll be doing. The tax treatment can be tricky, depending upon the length of time the house is rented.
But there are plenty of pros. Using your home to generate rental income can offset some of the costs associated with buying and maintaining the home. In some cases, owners can earn enough rental income to pay the mortgage, property taxes and insurance. In those cases, it’s like getting your vacation home for free — well, almost. It’s a growing trend: A recent report on second homes finds that of current second homeowners, about half use their home for personal use only, and 42.5% sometimes rent out their home as a short-term rental.
Another plus is that the home-rental management companies, including Vacasa, Airbnb and Vrbo, make it easy to list the home, find qualified renters and collect payment. They also have created cleaning policies to promote proper sanitizing procedures in-between house guests, a big plus during the time of the coronavirus.
And the timing right now couldn’t be better. Following a hiatus during the beginning of the pandemic that brought travel to an abrupt halt, demand for short-term vacation rentals is on the rise again. But the destinations considered the most desirable have shifted. Exotic far-away locations that require lengthy air travel have seen reduced demand while locations within driving distance have experienced a big uptick. Airbnb /zigman2/quotes/222990650/composite ABNB +1.90% put it this way: “This fall, guests itching to get out of their homes for a quick getaway are continuing to prioritize safer travel by discovering magic in their own backyards and on four wheels.” More than half of all bookings on Airbnb made in August were for trips within 300 miles of the guest’s origin.
Vacasa recently reported similar findings. Last year, people using Vacasa’s platform were booking vacations that, on average, were about 400 miles from their homes. But this year, that’s been scaled back to 330 miles.
Best places to buy
Some real estate consultants recommend that buyers of second homes who want to also rent out the property for maximum income focus on locations that are popular year-round or at least for several seasons.
A cabin in the mountains, for example, is good for hiking in the spring and summer and eyeing the fall foliage in autumn. And if the cabin is near a ski area such as the Berkshires in Massachusetts or the Rockies out West, renting during the winter months can also be lucrative. Some lakefront communities have all of the above along with an active summer season where families can enjoy a range of water activities — and often in locations that aren’t densely populated, which makes it easier to manage social exposure.
To earn maximum income from a vacation home, the conventional wisdom has been to avoid beach communities in locations with cold winters, which are popular for only a few months in the summer — typically Memorial Day to Labor Day — then deserted the rest of the year.
However, that view is changing. In recent years, more people have been renting beach houses during the offseason to enjoy the fresh air, explore the grass-covered sand dunes and take long walks on the beach without maneuvering through hordes of sunbathers. Many offseason renters are retired boomers, writers, researchers and actors traveling without children. But this fall, due to remote learning, a number of families with kids have become offseason renters as well.
Vacasa recently published “The top 25 Best Places to Buy a Vacation Home.” Of the top five locations, two are beach communities: Cape Hatteras, N.C., and Dauphin Island, Ala. Cape Hatteras is one of many beach towns in North Carolina’s Outer Banks region, which also includes Nags Head and Kitty Hawk. According to the Outer Banks Visitors Bureau, the number of vacationers arriving in the spring and fall increases every year, attracted by the mild weather, lower offseason costs and numerous outdoor events, including a seafood festival, jazz festival, water wildlife festival among others. While most festivals were canceled this year, they are expected to return once the Covid crisis is under control.
The remaining three locations at the top of Vacasa’s Best Places to Buy list are mountain communities: Big Sky, Mont., the Poconos in Pennsylvania and Gatlinburg, Tenn.
The Vacasa list ranks locations by capitalization rates, a real-estate investing term that estimates the expected rate of return on an investment property. The cap rate is calculated as the ratio of the income produced by the property and the cost or market value of the property. You can find the full list here .
The tax man
Some (rare) good news about taxes: For some unexplained reason, the IRS gives homeowners who rent out their properties a really sweet tax break known as the 14-day rule. It works like this. The IRS determines the tax treatment of a vacation home based on the number of days used personally and the number of days rented out.
If you rent out your property 14 days or less a year, you aren’t required to report the rental income on your taxes. It doesn’t matter if the rental income is $1,000 or $20,000, it’s tax-free.
Owners of homes in areas where pricey sporting events take place—think the Olympics or a Masters golf tournament—have been taking advantage of this tax break for decades. They can rent out their home for an astronomical sum for two weeks, then pocket the full profit.
If you rent out your home for 15 days or longer, that’s when things get tricky. Generally speaking, once you hit the 15-day threshold, you must pay taxes on the rental income but you also can deduct rental expenses, including cleaning, maintenance, utility bills and insurance. But the amount of expenses you can deduct depends upon whether the IRS considers your property a personal residence or a business. And that distinction is determined by the proportion of time you use the property personally relative to the amount of time you rent it out. And keep in mind that if you use one of the home-rental management companies, they will send your rental information to the IRS, so there’s no hiding. For more information, you can read the IRS publication .
The bottom line
For many families, generating rental income from a vacation home makes economic and financial sense. At the least, you can offset some of the costs associated with maintaining the home. At best, you pay off your mortgage faster or build up your savings. But you might want to consult a tax specialist before renting it out so frequently that the IRS designates it a home business.