Last updated on August 22, 2021
Vacation Home vs Investment Property: General Distinctions
Generally speaking, a vacation home is used for recreational purposes on a part-time basis by the owner. An investment property, on the other hand, is purchased with the intention of earning a return on investment, which can be in the form of rental income and/or the resale value of the property. From a tax perspective, the difference between a vacation home and investment property is a bit more nuanced.
From a general investment perspective a vacation home is considered an investment property as it will typically appreciate in value over time and may be rented out while not in use by the owner. From a tax perspective, the Internal Revenue Service uses specific thresholds to distinguish between a vacation home that is rented out part time and an investment property. Similarly, by renting out a vacation property more than occasionally, the Canada Revenue Agency may view your property as a commercial enterprise as opposed to a primary or secondary residence. In this article, we explore each of these considerations in more detail.
Return on Investment
There are two principle ways to earn a return on investment following the purchase of a vacation home:
1. Increase in Resale Value
The concept here is simple. Let’s say you purchase a family cottage for $250,000 cash. You make minor improvements of $10,000 over the years and sell it five years later for $350,000 (after real estate commissions and other expenses). That represents an ROI of 35% over the five year period and a pretty healthy return!
2. Rental Income
When we think of vacation homes, it’s hard not to see them as an investment overall, especially if rent is being collected. Even if the property is rented out for only a couple of weeks a year, income is still being earned. This differs from a primary residence. That extra money comes in handy when paying off the mortgage or other expenses associated with owning a vacation home. Total rental income will always vary according to the number of days that the property is made available for rent. Other factors such as time of the year and location, will also play a role. Overall, and done well, renting out a vacation property can help make it pay for itself.
Ownership Intent
Two scenarios are most common when it comes to investing in a vacation property, and they are specifically related to the owner’s feeling and their willingness to use the house themselves alongside the rental market or not. With the advent of short term rental platforms like Airbnb, the lines are often blurred as between using the property for personal use and for income generation purposes.
Scenario #1: Personal Use
In this scenario a buyer purchases a house in a place where they would like to spend their vacations and down time. The motivation is personal and pleasure seeking. They may use it a couple of weeks every year and the occasional weekend, and when they’re not there, they may also make it available for others to rent. From there, they make enough money to cover some of the expenses but not enough to necessarily earn a profit. In this scenario, its pleasure over profitability.
Scenario #2: Income Generation
The second scenario involves individuals that don’t necessarily use the vacation home for themselves (or only sparingly). They buy it for the purposes of renting it out and maximizing income. It’s available all-year-round and is managed just like a business. This may involve renting it out long term to a single tenant or short term on platforms such as Airbnb and VRBO. Certain owners may opt for renting it out by season according to the customer profile. In low season, they will focus on a longer-term rental at a slightly lower rate and in the high season shorter-term rentals that pay higher rates. In any case, the motivation is the same: maximizing profitability.
Vacation Home Tax Rules
The information in this section comparing tax rules for a vacation home vs investment property is provided for information purposes only. We strongly recommend you seek tax advice from a qualified accountant in order to better understand your individual tax situation.
United States
The IRS uses specific thresholds to distinguish between a vacation home that is rented out part time and an investment property. In particular, if you rent out your vacation property, you need to occupy it during the tax year for more than the greater of: (i) 14 days and (ii) 10% of the number of days you rent it out. By doing so, you can treat the vacation home as a secondary residence for tax purposes. Otherwise, in the eyes of the IRS it is an investment property. Also, if you use your second home as a residence and rent it for fewer than 15 days, you are similarly exempt from reporting any of the rental income. There is some overlap in the tax treatment of secondary residences and investment properties but there are also some differences. Be sure to speak with a qualified tax advisor to better understand the tax implications under either designation.
Canada
From the CRA’s perspective, renting a vacation property more than occasionally could trigger a “change in use” of that property for income tax purposes. Under such circumstances, the CRA will view your property as a commercial enterprise as opposed to a primary or secondary residence. Any such change in use will result in a deemed disposition of your vacation property at fair market value. Further, it may also necessitate becoming a GST/HST registrant.
Vacation Home vs Investment Property: So is a Vacation Home Considered Investment Property?
In summary, from a general investment perspective a vacation home is considered an investment property. It differs from a primary residence in the sense that, as its only being used part time, rental income can be generated while its not in use. Even if rental income isn’t being earned, owners can often enjoy a healthy return on investment through appreciation of the resale value. From a tax perspective, be sure to consult a qualified accountant in order to better understand the designation of your vacation home.
If you’re considering converting your vacation home to a rental property, be sure to explore our article on changing a second home to an investment property.
Curious as to whether buying a vacation home is a good investment? Click here to learn more.