Some usual tax benefits

Some tax benefits that are applicable on your first home are also valid for your retirement home. For instance, if you have taken a home mortgage to buy your second home, then you can claim tax deduction on the monthly payments you make to pay off your debt. Likewise, to ensure the safety of your new home, you must have taken an idyllic homeowners insurance policy. You can get tax benefits on the premiums of the insurance policy. Yet another area where tax deductions can be claimed is property taxes. These are some standard tax advantages that you get on buying your second home.

Rental income and tax benefits

Under normal circumstances, you won’t be living in your second home. If you rent out your unused premises, you can open a new source of income. In addition to getting regular rental income, you can also claim a number of tax deductions. There are three different scenarios of getting tax benefits.

You use more and rent out seldom- If you live in your second home and rent it out occasionally, that too for less than 15-days, then your will not get any tax benefits associated with rental. You don’t have to report your rental income in your annual income tax statement.

You use less and rent out regularly- In the second instance, you use your vacation home for less than 15-days in a year. For the remaining time period, tenants use your home. In such a case, you would have to declare your rental income in your tax statement. However, you become eligible for several tax benefits. Like, you can claim deductions on any repair work or alterations you undertake. You also get tax benefits on the rectification of damages caused by natural disasters as fire, earthquake, hurricane, tornado, etc. With time the value of the rental property depreciates; you can deduct the annual depreciation too. Another area where massive tax deductions can be applied is rental property management.

If your rental income is profitable, then you can deduct all the expenses pertaining to the management of rental property from the profit. However, if your rental property is not that profitable, then passive activity rule becomes applicable. According to this rule, if your rental income falls short of $100,000, then you claim a loss of at least $25,000. Things change slightly when your rental income is more than $100,000. In this scenario, the rental loss will continue to decrease until the rental income reaches the $150,000 mark. Thereafter, the rental loss won’t be considered.

You use some and rent out the rest- If you live in one half of your second home and the remaining half you have given on rent, then too you qualify for tax benefits. In this instance, you would have to report your rental income.

In nutshell, your second home is not just another lifeless property; it is a unique equity-building vehicle that helps you garner money easily and quickly.

When it comes to a luxury villa or a vacation home, the most difficult question to answer is: should you rent or buy? Most articles will give you tips, but we want to give you a low down about home ownership in the USA.

Fact: When you own a home, you will need to maintain it. Maintenance costs can be higher than a thousand dollars in a certain year. On the other hand, rental homes are maintained by their owners or a real estate agency. If you are just looking for a vacation home, then it is best to rent.

Fact: Local government is always raising property taxes, and if you are living in rental houses, you don’t have to pay these.

Fact: If you are a homeowner, you will need to have a homeowner’s insurance – you know, just in case there’s a fire or if a burglary happens, then your home is secure. If you are renting a condominium or a duplex, then you can be sure that your home is secured without additional costs since the homeowner will have to pay for the insurance.

Fact: You have to put in a lot of labor in your home, or you will need to pay for someone to do it. you need to repaint the house every four to eight years – that’s a minimum of $25 per gallon of good paint. If you are living in a luxury villa, then your costs will be so much higher. But if you’re renting it, then all you have to do is call the owner and let them do it for you.

Fact: Modern windows have a 20 year lifespan. Water heaters last up to 6 to 10 years. Furnaces need to be replaced every 10 to 25 years. Asphalt shingles lasts up to 15 to 25 years. If you have no plans on moving, then you should save up for all these replacements. If you were renting a single-family home, then you don’t need to worry since the owner will handle all these costs.

Fact: If you own a home, then you’re responsible for the sidewalk, the curb and the gutter in front of your home. You need to pay to put it in and pay again to get it replaced.

Fact: You are responsible for the trees which are in your property. You need to trim them so that they don’t reach the power lines, you need to keep the branches out of the streets and out of the sidewalk. You need to get the leaves cleaned up. If you were a renter, you don’t have to do all these – you save not only money, but your time as well.

Fact: When you own a house, you’ll never know how much you’ll have to spend in a month since you might need emergency repairs such as a leak in the toilet pipes, or when your appliances break down. If you lived in rental homes, then you only need to pay for your monthly dues.

Now, why own a home if renting one is so much easier?

Making a Fair Comparison

In order to fairly evaluate the individual merits of owning a home versus renting, we must first place the cash flows required on equal footing, and then we can evaluate the future value of each option. For example, let’s say you want to buy a house that will require a monthly cash outlay of $1,000, which includes mortgage payment, basic fire insurance, principle mortgage insurance, neighborhood association dues, property taxes, basic maintenance, etc. The rental you are considering will cost you $500 per month, which includes rent and rental content insurance. To make a fair comparison, we would have to add an extra $500 in cash flow to the rental option, which we will invest into a stock index mutual fund returning 10% annually over the long term. If we estimate to live in the home for 10 years, we would next calculate what the value of the stock market investment would become, and then calculate the equity we will have built in the home, accounting for principle payments and price appreciation. The option with the largest total wins!

A Real World Example

Let’s assume you are currently renting a home for $600 per month plus an extra $25 for rental content insurance. Over the years, you have managed to save several thousand dollars for the purchase of a new home. You find a home you absolutely love for $100,000. This home will require monthly insurance payments (fire & flood) of $100, property taxes of $1,000 per year, annual maintenance expenses of approximately $500, and $3,000 in closing costs. If you put $20,000 down on a 30 year mortgage at 6%, your monthly mortgage payments will be $480, and total expenses will reach $705 per month. Assuming you hold onto the home for 10 years and the home appreciates at 3% annually, you will realize a profit of $67,987. The home purchase option sounds good so far, doesn’t it?

Now let’s look into the rental option. To equalize the cash flows, we will immediately invest $23,000 into our stock index mutual fund – $20,000 for the down payment and $3,000 for the closing costs. Also, for the entire 10 year period, we will invest $80 per month in our stock index mutual fund to account for the difference in monthly cash flow between the two options. Assuming the stock index mutual fund returns 10% annually, at the end of the 10 year period your account value will be $78,576 – or $10,589 MORE THAN THE PROFIT REALIZED FROM THE HOME PURCHASE OPTION! In this example, the rental option is the correct choice.

Summary

From a strictly financial perspective, the correct choice between renting and owning changes frequently and depends on many factors. The key thing to remember is that to make a fair comparison, the cash flows between the options must be placed on equal footing. Once this is accomplished, the option with largest accumulated profit is the correct one.

Equity vs. Investments

It’s true that paying a mortgage versus paying rent means you’re building equity in your home. However, you could actually be losing money, especially when the market is in a downturn.

Let’s say you would spend $2000 a month on your mortgage, not including your home maintenance costs and taxes, and your home is either currently depreciating or only appreciating at a nominal rate. But, your current rent is costing you only $1200 a month. If you invested that extra $800 a month in even a low-yielding savings account, you could actually build more financial assets at a faster rate than a home could.

Now throw in your home maintenance expenses and taxes that we excluded above – also adding in additional amounts for almost inevitably higher homeowners insurance, gas, electric, water, and potentially neighborhood covenant fees – and the savings you realize each month through renting becomes even more noticeable.

Maintenance and Workload

When you rent instead of own, you typically don’t have to think about managing the grounds, doing repairs, maintaining appliances or fixing the roof.

Not only do you save on the time and labor that home maintenance takes, but you also save on the cost. Most new homeowners should expect to budget between $200 to $300 a month for home repairs and maintenance. That’s $200 to $300 that you could be investing and hours of time that you can spend enjoying the benefits of your returns.

Taxes and Liabilities

Property taxes are typically the responsibility of the land owner. This means, as a tenant, you’re not responsible for property taxes, which usually cost a few thousand dollars per year, depending on the county assessed value of the property.

In addition to saving on taxes, you can also save on liability risks and insurance. Outside of your apartment, and sometimes even inside your apartment, your landlord is taking the liability risk if someone trips, injures themselves and decides to sue.

Because of reduced liability and, of course, a lack of invested equity in the property, tenant’s insurance is significantly less than home insurance – as noted earlier. As a tenant, you’re only insuring the contents of a property and your own limited liability, not the property itself. That’s another few hundred dollars every year that can go into your investment account rather than into your property.

Admittedly, there are benefits to owning a home – whether it’s decision-making power, space, long-term ownership and financial return, or not having to put money in your landlord’s pocket. However, if you look at a home as an investment, and weigh it against the returns you can achieve through other means of investment, you’ll quickly see the rate of return might not be as great as you think. Renting definitely has its advantages.