What Is a Vacation Home?

A vacation home is secondary dwelling, other than the owner's principal residence, and is used primarily for recreational purposes including vacations or holidays. Also known as a recreational or secondary property or residence, a vacation home is often situated in a different location from the owner's primary residence. Because vacation homes are only used at certain times of year, many owners rent out these dwellings when they are not using them.

Key Takeaways

  • A vacation home is a property aside from one's primary residence, that is used mainly for vacationing.
  • A vacation home is often located some distance away from the primary residence.
  • Mortgages for vacation homes generally come with higher interest rates because they have a higher risk for default than a primary residence.
  • Vacation properties may also be rented out to produce additional income when it's not being used.

Understanding Vacation Homes

Property is divided into several different categories, usually for income tax purposes. The property that a homeowner lives in is referred to as their principal or primary residence. This property can be a home, apartment, condominium, or trailer. In order to qualify as a principal residence, the homeowner—whether that's a single individual, couple, or a family—lives for the majority of the year.

A vacation home, on the other hand, is much different. This type of property is often considered to be a second home. In most cases, it's in a different location than the owner's primary, principal residence. As noted above, the owner may use this property for recreational purposes including vacations, usually for a few days or weeks each year. Just like primary residences, vacation homes can take any form—the most popular being cottages and condos.

Aside from providing the homeowner with a place to get away, vacation properties can also be rented out to produce additional income when it's not being used. So a couple with a principal residence in Maine may own a vacation home in Florida during Maine's coldest months and rent it out to other people for the rest of the year. But there are a few things the property owner needs to consider including how it's treated for tax purposes. There may be limitations as to how long the owner can reside there and still deduct rental expenses. The sale of a vacation home does not allow for the same income tax deductions as the sale of a primary residence does.

Although they're a great asset to have, vacation homes may be a financial challenge. For instance, a mortgage on a vacation home typically has a higher interest rate than a loan on a homeowner's primary residence. That's because they have a higher risk of default as individuals are more apt to save their primary residence than a temporary one in the event of a reversal of fortune.

Special Considerations

In order for a vacation home to be classified as a residence, it must offer basic living accommodations including sleeping space as well as cooking and bathroom facilities. The home must also be used for personal purposes for more than 14 days and 10% of the total number of days the home is rented at a fair rental value. It is also increasingly popular to rent out vacation homes on a short-term basis through services like Airbnb or HomeAway.

The vacation home tax rules for a residence will apply if those requirements are met. Deductible expenses would include the rental portion of qualified home mortgage interest, real estate taxes, and casualty losses. Other expenses that can be deducted stem directly from the rental property and include advertising, payment of commissions, legal fees, and office supplies. Expenses related to the maintenance and operation of the rental property are also deductible.

If a vacation home is rented out for 15 days or more per year, the rental income must be reported to the Internal Revenue Service (IRS) using Schedule E. Owners can also deduct any expenses associated with that residence. If the home is considered a personal residence, the deducted expenses cannot exceed the rental income. If the vacation home is not a personal residence, the deducted expenses can exceed this threshold, but the reported loss may be limited by passive-activity regulations.

Income must be reported if a vacation home is rented for 15 days or more each year.

When the owner of a vacation home sells the property, they should plan on capital gains, which must be reported to the IRS. That's because vacation homes are treated as personal capital assets. Owners are taxed on the profits of the sale, which are reported on Schedule D—for the year the property was sold. This form accompanies the owner's annual tax return. This is contrary to a primary residence, which is exempt from the first $250,000 for single filers or $500,000 for couples filing jointly.

Vacation Home vs. Investment Property

Some vacation homes may be considered investment properties, but not all investment properties are vacation homes. As mentioned above, the owner of a vacation home may use it to produce extra rental income, making it an investment property when they're not using it. But someone who buys an investment property does so for the sole purpose of generating income either through rent or the future resale of the property. Unlike vacation properties, investment properties don't need to be homes. They can be residential as well as commercial properties, or even mixed-use structures—properties with both residential and retail spaces.