How the New Tax Law Impacts Vacation Homes

by Steve CookJune 26, 2018

It’s that time of the year when families consider the pros and cons of buying a vacation home. Vacation homes are a great way to convert the money spent on rent every year into a long-term investment. With the right property in a popular destination, a vacation home can become affordable for millions of families.

Two Adirondack style chairs sitting on a wooden deck facing the shore. There is a large home in the background. Horizontal shot.

The tax reform legislation enacted late last year made some significant changes in the tax treatment of real estate that may influence your decision to buy a vacation home. The most significant changes involve two popular tax deductions, the mortgage interest deduction and the deduction for state and local property taxes. Many vacation homeowners may find that these changes reduce the value of these deductions so much that they will be better off taking the standard deduction, which was doubled in value, rather than itemizing deductions.

The new limit on the deduction of state and local taxes will make second homes more expensive.

Before passage of the new tax law, there was no limit on how much taxpayers could deduct in state and local taxes. The new ceiling of $10,000 on state and local taxes will make owning a second home significantly more expensive. With today’s rising tax assessments, millions of homeowners with just one home pay more than $10,000 in property taxes and state income taxes a year. The addition of a second home could easily double the amount that vacation homeowners will pay, mainly because property and sales taxes in most resort areas are higher than elsewhere to capture revenues from tourists and seasonal visitors. Homeowners who in live in states with higher property and income taxes, mainly on the West Coast and Northeast, will also lose more than those in the Midwest and South.

When figuring out your state and local taxes, first calculate how much you currently deduct in state and local taxes by reviewing your 2017 tax return. Add the amount of property and state income taxes you paid along with state and local sales taxes. Add to the total the amount of property tax you paid last year to give a general idea of how much you will spend for the addition of a vacation home. Subtract $10,000 from the total, and the difference is the amount of local and state taxes you will pay in 2018 that you will not be able to deduct.

The extra costs of owning a vacation home caused by this new limit will be high enough that some economics suggest it will decrease vacation home values by 10 percent, which might give buyers a small payback for the additional taxes they will have to pay for years to come.

A new cap on the mortgage interest deduction will make a second home more expensive for middle to upper-class vacation homeowners.

Under the old law, homeowners could deduct the mortgage interest they pay up to a maximum of $1 million in mortgage debt for a joint return and $500,000 for a single return. The new tax law lowered that cap to $750,000 of debt. As a result, millions of second homeowners whose total mortgage debt exceeds $750,000 will not be able to deduct all of their mortgage interest on their 2018 taxes.

For those who have a mortgage on a primary and a second home, both mortgages will count towards the new ceiling, which means that second homeowners with less than luxury homes will not be able to deduct all of the mortgage interest they pay.

For example, if you buy a vacation home with a $450,000 mortgage and you also owe $400,000 on your primary home, you will only be able to deduct the interest you pay on the first $750,000 of your mortgage debt.

There’s a silver lining for current homeowners in the new law. Mortgages that closed before December 15, 2017, are “grandfathered.” For them, the million-dollar ceiling will remain in effect. That will make it a little easier for existing homeowners to buy a vacation home now. As time passes, prices continue to rise, and more homeowners sell or refinance. The lower cap on the mortgage interest deduction will diminish its value to the middle class as well as wealthier owners.

Bigger standard deduction dilutes homeownership incentives.

The new law doubles the standard deduction for a joint return from $12,000 to $24,000, high enough to make millions of homeowners forgo itemizing. Even new homeowners who are paying mostly interest in the early years of their mortgages and are also paying stiff property taxes could be better off taking the standard deduction. However, erasing tax benefits for homeownership removes an incentive to buy a home. Negating tax incentives for homeownership, like setting a ceiling on property tax deductibility, could reduce home values−arguably a good move in overheated markets but not for owners.

Family With Luggage Leaving House For Vacation.

Despite these tax changes, buying a vacation home today can be a great investment. As resort area rents and property values continue to appreciate at attractive rates, families that buy vacation homes today become the beneficiaries of market conditions. Rental listing sites and property management companies relieve owners of most of the burdens of being a landlord.

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About The Author
Steve Cook
Steve Cook is editor and co-publisher of Real Estate Economy Watch. He is a member of the board of the National Association of Real Estate Editors and writes for several leading Web sites, including Inman News. From 1999 to 2007 he was vice president for public affairs at the National Association of Realtors.