Changes the Republican Party is looking to make to the tax code could shift the calculus for people considering buying a second home.
As part of their tax code overhaul, Republican lawmakers have taken aim at the mortgage interest deduction. While the deduction will be retained, they plan to modify it substantially — and some of the proposed changes would squarely hit people who own second or vacation homes.
Under the proposed legislation, people with a second home will no longer be able to deduct the interest paid on a mortgage for that property. Currently, people are allowed to deduct mortgage interest paid on two properties up to $1 million in debt.
Additionally, the new provision would no longer allow taxpayers to deduct interest paid on home equity loans. Taxpayers currently can deduct interest on up to $100,000 in home equity indebtedness. This change appeared likely to limit a popular strategy among vacation-home buyers — taking out a home equity loan on their primary residence to fund a down payment on a vacation property or pay for it outright.
As with other changes made to the tax code, it appears that the new provisions will only apply to people who finance the purchase of a second home in the future. And people who own a second home should be able to continue deducting what they pay in property taxes for their additional home. Still, these changes will alter how financially feasible owning a vacation home might be.
This change doesn’t just impact wealthy people
While vacation homes might be more commonly associated with people who live lavish lifestyles, these changes will hit middle-class homeowners too. “It’s not as sympathetic a cause as impacting your traditional owner-occupant, but it is a very real aspect of what’s going on,” said Rick Sharga, executive vice president of online real-estate marketplace Ten-X.
The median income of vacation-property buyers in 2016 was $89,900, according to data from the National Association of Realtors, which was significantly higher than the median among people who were buying homes they would primarily live in ($75,000).
Still, the vast majority of vacation property buyers don’t necessarily live the lifestyles of the rich and famous: Only 34% of vacation-home buyers have a household income of more than $100,000 annually, while 10% earned less than $45,000 a year.
Consequently, critics of the changes made to the mortgage interest deduction argued that the new provision was still more likely to affect middle-class folks even in the vacation-home market. “They’re the ones who really needed that deduction,” said Brian Koss, executive vice president at Mortgage Network, a lender headquartered in Danvers, Mass.
Not all vacation communities will be affected equally
Real-estate experts have argued that the changes Republicans have proposed could depress home prices in some housing markets if they became law —at least in the short-term. And that theory applies to vacation communities, too.
But don’t expect to see the poshest getaways being the hardest hit by this change, Koss said. “Your really high-end vacation areas aren’t going to feel the pinch,” Koss said. “It’s not going to be Aspen and Nantucket, it’s going to be the Jersey Shore.”
Consequently, the new tax plan could depress sales in some of these markets at a time when sales have already suffered because of rising home prices. Vacation-home sales have already taken a hit in recent years: The share of vacation-home buyers dropped for the third straight year in 2016 to 12% from 16% the year before, according to data from the National Association of Realtors.
The market-related effects the tax plan could have won’t just affect vacation-home buyers though — it could also extend to those who live year-round in these communities.
People looking to offset these tax-code changes need to be careful
Though mortgage financing is less common among vacation property buyers, it’s still important to this market. Nearly a third of vacation-home buyers (28%) didn’t use a mortgage, versus just 13% of those who were purchasing a primary residence.
Experts predicted that some people considering buying a second home might consider alternative means of offsetting the costs of a mortgage. “This change doesn’t necessarily apply to homeowners who have a second home that they rent out the majority of the time,” said Danielle Hale, chief economist at Realtor.com. “It might cause more people to shift to rent those types of properties.” (Realtor.com is operated by News Corp subsidiary Move Inc., and MarketWatch is a unit of Dow Jones, which is also a subsidiary of News Corp.)
Homeowners considering listing their vacation property on a site like Airbnb could quickly find themselves in a taxation quagmire if they’re not careful. People who own a second home can rent it out for up to 14 days each year without needing to pay taxes on the rental income, according to HouseLogic. After that point, what they earn from renting would be taxable.
Some owners might see greater deductions if they classify their home as a business property — particularly because they could write-off expenses related to renting it out including utilities, repairs and insurance.
There’s a trade-off to this strategy though: Homeowners need to be careful that they don’t stay at the home too often. These individuals need to restrict personal use of their property to fewer than 15 days or 10% of the total number of days they rent it out, whichever is more, according to HouseLogic. If they stay longer than that, the Internal Revenue Service will consider it a personal property, meaning they’d be on the hook for taxes on their rental income and be limited to state and local property taxes as their only deduction.