A field guide to finding your perfect seasonal residence

Whatever your reason for seeking a second residence, how do you choose the one that’s best for your situation? I like the advice that Charles Nilsen, Executive Vice President and National Director of Residential Lending here at SVB Private, gives to potential vacation home buyers: “Consider the practical and emotional value of the property—as well as its cost and location—before you take the plunge,” he says.

It’s easy to fall in love with a great property at a good price, but make sure you consider other factors too before jumping in,

Nilsen cautions. Here are the questions you might ask yourself.

1. What’s the best location for me — and my family — now and later?

Think about why you’re buying the property. Is climate a big factor? How about proximity to activities and interests you enjoy, such as searching for antiques, golfing, boating, fishing, or skiing? Do you want something more remote and rustic? Or is being close to good shopping, entertainment, and restaurants important to you?

If one of your goals is to invest in a place that brings friends and family together consider its distance and ease of access for the people who will be visiting you. If you plan to retire to the second home, think about its proximity to healthcare services in the future and the importance of building a network of friends and supportive relationships there.

2. How will I finance it?

Depending on your financial situation, you may decide to buy or build your second home with cash and forgo another mortgage payment. But instead of dipping into your investments and taking a tax hit, there is another option: borrowing against your investments with a line of credit. That’s what Max and Susan Lee did when they decided to build a second home near the ski resort that their family had gone to for years.

When they sold their business a few months earlier, the Lees had put the proceeds into a diversified portfolio of investments that could potentially keep their money growing throughout their retirement. So when they needed money for the construction of their vacation home, they were reluctant to tap into that nest egg and sell assets that would incur capital gains. Instead, they decided to pull cash out of a flexible line of credit secured by their SVB Private Wealth investment account.

This strategy allowed them to keep their diversified assets at work while they paid the contractor. And the cost of the variable rate line of credit was more favorable than any construction loan they could secure. Once the home was finished, they took out a conventional 15-year mortgage to pay off the credit line at a low fixed rate.

3. Will this affect my other financial plans and priorities?

As recent wildfires, floods, and hurricanes remind us, it’s also important to make sure your property is adequately protected and insured against both natural disasters and man-made ones. You’ll want to factor in the high cost of flood and storm insurance if you’re buying near the ocean or on a river and the cost (and availability) of fire insurance if you’re in a remote location that relies on a volunteer fire crew.

There also may be covenants on shoreline property that restrict how and what you can build to prevent future storm damage and beach erosion. And if you plan on renting out your property, you’ll want to check on whether your casualty insurance and personal liability limits should be higher.

If you’re thinking about purchasing a vacation property purely for its investment potential, do so with some caution. Real estate can be a good diversification strategy because its performance is not correlated to stocks. But you also don’t want to overdo your allocation to real estate by purchasing an individual property that will be a large, illiquid asset in your investment mix.

4. How will it affect my tax situation?

You’ll want to check in with your accountant and tax advisor before you buy a seasonal residence to understand the tax implications of your purchase.

You may find that the real estate taxes for your vacation property are much higher than those for your primary residence because the town or state has lower tax revenues. Or you may want to look for a location for your eventual retirement where you won’t have to pay any state or local income taxes at all if you become a resident (like New Hampshire, Florida, and Nevada).

In addition, the 2018 Tax Cuts and Jobs Act limits how much you can deduct for mortgage interest and property taxes paid on your second home. Under the new tax law:

• The maximum deduction you can take each year on your federal tax return for state and local taxes (a.k.a. the “SALT” deduction) is $10,000.
• Joint tax filers can only deduct mortgage interest on up to $750,000 of the mortgage debt incurred to buy or improve a first or second residence. For married couples filing separate returns, the limit is $375,000.

One more tax-related item to think about: Depending on where you live, you may be able to avoid paying some taxes in the state of your primary residence when you spend time at your vacation home. If you live in New York and own a home on the Connecticut shore, for instance, you can deduct the percentage of days you’re in Connecticut from your New York state tax obligation.

5. Should I consider becoming a permanent resident in the new location?

If you’re thinking about changing your primary residence from your current home to your vacation property as you get closer to retirement, knowing the rules for residency is key because they can vary from state to state.

Most states use both quantitative (number of days in the state) and qualitative (facts and circumstances) ‘tests’ to determine residency/domicile for tax purposes, but the details for every state are different. Typically, to be considered a full-time resident in a new state (i.e., change your tax domicile) you must sever “tax ties” with the jurisdiction you are leaving and build new ties (both formal and informal) in the state in where you intend to establish residency.

6. What are the estate and legacy planning implications?

Purchasing a new vacation property also may mean making changes in both your will and your trust documents to reflect how you want the new asset to be managed at your death or incapacity. You’ll need to decide:

• How will you title the asset? In your own name (jointly or individually)? Or in the name of your trust?”
• If the property is in another state, should you put it in a trust to avoid probate in two separate states?
• If you rent out your vacation home, should you hold the property in an LLC to reduce your personal liability?
• Will you gift your vacation home outright to your children (or other beneficiaries) or will you create partial interests to be divided among them and then held in trust?

If your vacation home becomes your permanent residence, you’ll need to revise your will, trusts, and other estate planning documents to reflect this change too. This is particularly important if the new state has different marital property rules or special forms for medical directives, healthcare proxies, and powers of attorney.

If you have already funded a living trust in your former state, this could trigger income tax consequences in that state regardless of whether you are still a resident there. It would be best to terminate that previously funded trust and transfer the assets into a new trust established in your new state.

If you’re purchasing a residence in a continuing care retirement community, make sure you ask your advisor to look over the terms to understand how it could affect your cash flow and estate plan.