Demand for vacation homes continues to skyrocket. Before you buy another home, make sure you’ve thought through these four considerations.
Whether it’s a cozy beach house or a ski chalet, a vacation home — or homes in multiple locations — can be an amazing resource for those looking for an escape. The appeal of a private getaway reached new levels during the pandemic and continues to grow: Research shows that demand for second homes in January 2022 was up 87% over pre-pandemic levels — even as interest rates continued to rise.1
“Vacation homes tend to be where you have family holidays, weddings, family reunions, and special events,” says Matthew Mozer, a senior wealth planner with Wells Fargo Bank in the Wealth & Investment Management division. “Because of that, no matter the destination, one of the first considerations is likely to focus on homes that are accessible to multiple people and can be passed to future generations.”
With that in mind, Mozer shares four considerations that potential buyers should think about when exploring the purchase of an additional home.
1. Consider establishing a Limited Liability Company (LLC)
Once you start investing in multiple properties, especially once you get to your third or fourth property, Mozer says, it can be beneficial to form an LLC for the ownership of the home. This can help protect your estate and your privacy.
“Creating an LLC can help provide a first layer of liability protection in terms of separating personal assets from business assets,” says Mozer. “The LLC can also provide privacy. It’s easy to look up tax records and see who owns what home. In this case, the LLC would be listed as the owner, instead of your name.” An LLC can also ease the process of transitioning your vacation home into a rental home, should you decide to do so in the future. You can consult with your legal advisor to learn more about forming an LLC for this purpose.
2. Think through the potential impact of paying cash versus borrowing
Deciding to purchase your vacation home with cash or via a mortgage may come down to your liquid assets and what your net worth is, says Mozer. He believes, at most, you’ll want to spend 10% of your net worth on a third or fourth home. But if an all-cash sale means liquidating assets, it may do more harm than good.
“I am in favor of purchasing a vacation home with some cash and acquiring some credit or borrowing to complete the purchase,” Mozer says. “I think you may be better off incorporating credit or lending for the purchase considering that interest rates are still relatively low. Selling marketable securities for the liquidity you need means you will forgo any potential growth of those investments.” (Learn more about how much cash to have on hand now.)
3. Be ready to review your estate plan
Once you’ve purchased your vacation home, you’ll need to consider how to categorize it in your estate plan. To avoid the lengthy and expensive probate process, Mozer recommends placing your property (or your LLC that owns your property) in a revocable trust.
Mozer says, “Any assets that are owned by the revocable trust are in your complete control and can help you avoid the probate process, which can be delayed by a court system slowing down the administration process.” Much like forming an LLC, purchasing a home in the name of a revocable trust can provide a layer of privacy around your purchase.
“If you have a will, anyone can see what money you’ve left, who you’ve left that money to, and who your beneficiaries are,” Mozer says. “If you say in your will, ‘I leave everything to my revocable trust,’ then the contents of your specific bequests are not public.” An estate planning attorney can help you explore your revocable trust options. (You can learn more about other types of trusts here.)
4. Keep your family legacy in mind
Your properties will become a part of your family legacy, one you may eventually pass to future generations. To help protect that legacy — and your investment — consider placing the property in a qualified personal residence trust (QPRT) for an extra layer of protection alongside your LLC and revocable trust.
“A qualified personal residence trust provides some estate-tax savings and planning opportunities for the property,” Mozer says. “The buyers, likely the parents in the family, will retain the right to use and live in the property for a period of time. Then after that period of time, based on my experience, say five or 10 years, the ownership transfers to the qualified personal residence trust.”
By placing a property in a QPRT, you help ensure that future generations not only have access to the property but have the means to maintain it as well.
“This can benefit the next generation while also helping to reduce the amount you need to include on your estate tax return,” Mozer says. “The parents can also fund the trust with additional cash and investment gifts so that when they pass, the trust can pay for maintenance, real estate taxes, everything.” An estate planning attorney can offer guidance on this topic as well.
- Dana Anderson, “Vacation-Home Boom Continues Into 2022, With Demand Up Nearly 90% From Pre-Pandemic Levels,” Redfin, February 10, 2022, https://www.redfin.com/news/vacation-homes-january-2022/
Wells Fargo Wealth & Investment Management (WIM) is a division within Wells Fargo & Company. WIM provides financial products and services through various bank and brokerage affiliates of Wells Fargo & Company.
Wells Fargo & Company and its affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.
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