Hidden Costs of Buying A Lake Home: Tips for First-time Buyers

Chalk drawing of a house with a key in the doorway next to a fanned out stack of $100 bills the hidden costs of buying a lake home

It’s no secret that lake property typically costs more. If you are shopping for your first lake home, chances are you’re extremely aware of this! What many first-time buyers don’t know is that there are several hidden costs of buying a lake home that may lie just beneath the surface.

While you are busy falling in love with that gorgeous lake home of your dreams, keep the following factors in mind. Your budget will thank you!

Leased Lots

Even with a traditional mortgage, buying a lake home may involve leasing the land itself.

This is most common on waterfront property. The power company, the local municipality, or even the federal government may own the lake itself – and that often includes the shoreline.

When you purchase a home on a “leased lot,” you enter into a long-term lease with the owner.

These are not complicated, but it can be a significant expense. Leases typically run between $200 and $500 a month, depending on the area. Depending on the area, your lease could last anywhere from 20 to 100 years!

When on the waterfront, ask always find out who owns the shoreline. This can be a huge factor in your budget.

Property Taxes

Lake property is subject to higher property taxes as well, and if your lake home is going to be a second home, that can make tax season incredibly complicated.

These hidden costs of buying a lake home often don’t pop up until you’ve already been in the home for months.

Many lake homeowners have their primary residence in different counties or even states. Research the local laws and tax rates for your lake home. Don’t be afraid to consult with an accountant!

If you rent out your lake home, you may also be subject to income tax.

Insurance

Person holding clipboard with insurance contract

Homeowner’s insurance is usually higher for lake homes due to their increased exposure to the elements. Having good coverage is a wise choice to begin with. Unfortunately, that choice might already be made for you.

Local laws and insurance companies often mandate a higher level of insurance coverage for lake homes, including flood insurance.

Remember that you need to get coverage for any additional structures on the property, such as your dock, guest house, or sea wall. Your homeowner’s insurance policy may not cover them automatically.

Flood insurance should always be seriously considered for lake property. After the floodwaters recede, this protection can mean the difference between a serious hassle and a financial disaster.

HVAC and Septic Systems

According to Wally Cawthon, a Lake Homes Realty agent on Jackson Lake, Georgia, “The two biggest unexpected and preventable expenses for first-time lake home buyers are repairs to HVAC systems and septic systems. If buyers take proper inspection measures, they can avoid these in almost every case.”

Many lake homes, especially in rural areas, use a septic system.

These need to inspected regularly to ensure that they don’t pollute the local water table, or the lake itself.

Never purchase a lake home with a septic system before having it professionally inspected.

This typically costs $200 to $500, and is money well spent. Replacing a seriously damaged septic system can easily cost up to $7,000.

HVAC systems should also be thoroughly inspected before buying.

A home that looks picture-perfect when the weather is mild can still house an HVAC system long past its prime.

Buy without having it inspected, and you may be in for a rude surprise (and an even more rude repair bill) when you take ownership.

Outdated HVAC systems can also churn through electricity, especially in the chilly winter months.

Boat Docks

Lake house floating boat deck
Photo courtesy of Custom Dock Systems.

Building a dock on your property is no small project. According to homeadvisor.com, the average homeowner spends $3,396 in dock construction.

Depending on the specifications, a high-quality, permanent dock can cost more than $50,000. Factors such as size, water depth, climate, and other factors all contribute to this cost.

If part of your dream home involves building a dock, get a professional estimate on dock construction, then factor that cost into your budget for the new home.

On the other hand, you may have your eye on property that already has a dock.

If so, ask the selling agent if they know how old it is. Most wooden docks last 20 to 25 years. Purchasing one that is due to be replaced can be a serious hit to your wallet!

Know how your homeowner’s insurance policy covers your dock. Many policies cover the structure from incidental damage, but not damage due to flooding, freezing, or thawing.

Utilities

Many lakes are situated in pristine, secluded, rural areas. This means that power, water, cable, and other utilities often come at a premium.

Lake homes need a dedicated “land line” for the telephone. Between the rural locations and limited cellular service providers, you never want to rely entirely on a cell phone.

This may seem like a trivial concern. Lake homeowners can attest, though, that these hidden costs of buying a lake home add up quickly.

You will find this doubly true if your lake house is a second home. This is why many lake homeowners “winterize” their homes in the winter months, cutting off the power, gas, and water when it isn’t in use.

Homeowner’s Associations

Person signing homeowner association contract the hidden costs of buying a lake home

Last but not least, many lake homes are part of a homeowner’s association.

These associations often serve the same role as small-town municipalities around the lake itself. They maintain the lake, set local regulations, and preserve the natural beauty of the area.

Homeowner’s association dues usually make up a small, but mandatory, annual cost.

It’s a good idea to acquaint yourself with the association before purchasing the home. This can give you an inside look at the local culture, including your future neighbors!

Do the Research

These are the most common costs to take into consideration. When researching a lake home, factor these into your budget early on.

Curious about the hidden costs that come after the purchase of a lake home? Read our article, “The Hidden Costs of Keeping A Lake Home: Tips for First-time Buyers“, or find more advice and tips on lake living here.

Deductions Aren’t the Only Way to Save on Real Estate Taxes

man in suit holding up white house outline

By Bill Brown, 2017 President of the NATIONAL ASSOCIATION OF REALTORS®.

Learn more about Bill on NerdWallet’s Ask an Advisor

The mortgage interest deduction and the state and local property tax deduction are probably the best-known tax incentives for homeownership and real estate investment.

That’s no surprise. Roughly nine out of 10 home buyers borrow money to buy a home, meaning they likely pay some form of mortgage interest. And property taxes are a near-universal expense for homeowners.

Both deductions are crucial to making homeownership possible for the average buyer.

But there are other real estate-related tax incentives that might not be as familiar.

Capital gains exclusion

All homeowners hope their property will appreciate.

The flip side is that anyone selling an asset that has gone up in value may get hit with a tax bill for the profit, also known as the capital gain. Thankfully, homeowners have some help in their corner.

An individual selling his or her principal home can qualify for an exclusion of up to $250,000 in capital gains, and married people who file jointly may qualify for an exclusion of up to $500,000.

There’s no need to report gains up to these limits on a tax return.

To take the exclusion, sellers must pass the IRS’ ownership and use test, but it’s fairly straightforward.

Essentially, they must own the property and have used it as a primary residence for a total of two out of the five years preceding the sale. Even if owners currently rent the property and depreciate it — as we’ll discuss shortly — they might still meet the use and ownership test and qualify for the exclusion. And even if sellers haven’t lived in the home during the past five years, they might qualify for a partial exclusion.

That’s a big help, as well as a recognition of the fact that millions of Americans depend on their home to build wealth throughout their lives.

1031 like-kind exchanges

The “1031 like-kind exchange” sounds like it’s ripped right from an accountancy textbook, but it’s actually fairly easy to understand.

Let’s say a person owns a single-family, detached rental home as part of an investment portfolio. If the home appreciates, the owner will likely owe capital gains taxes in the event of a sale — unless he or she uses the proceeds to buy a condominium in a market with higher rents.

Because the single-family home and the condo are both investment properties, tax law treats them as “like kind.” And because this transaction is a “like-kind exchange,” the owner won’t pay capital gains tax until he or she sells the new property.

This gives investors an incentive to put any realized gains back into the economy rather than pocketing them. And it’s a big deal: Major real estate investors and mom-and-pop investors alike can benefit.

Depreciation on rental property

Homeowners who rent a portion or all of their property might be able to “depreciate” that asset, which means deducting some of the cost of the property each year on their tax return.

That could result in a significant income tax deduction.

If you do earn money on the sale of your home after depreciation is taken into account, you’ll generally owe tax on the depreciated portion at the 25 percent “depreciation recapture” rate.

Any other gains will be taxed as capital gains.

Changes may be coming

For more than a century, the United States has recognized the benefits of homeownership and real estate investment.

It strengthens communities and helps individuals grow nest eggs for themselves. However, Congress is considering tax reform proposals that could have sweeping implications for real estate incentives.

That’s something to keep an eye on.

Everyone’s tax situation is unique. Before you count on any of these incentives, you may want to talk with a tax professional. But if you’re ready to take the plunge into homeownership or real estate investment, tax benefits — some obvious and others perhaps less so — are out there.

Bill Brown is the incoming president of the National Association of Realtors.

The article Deductions Aren’t the Only Way to Save on Real Estate Taxes originally appeared on NerdWallet.

NerdWallet is a Lake Homes Realty / LakeHomes.com content partner providing real estate news and commentary. Its content is produced independently of Lake Homes Realty and LakeHomes.com.

Assessing Your Vacation Home’s True Rental Potential

assessing the situation with a calculator

At first blush, many prospective buyers see the purchase of a vacation rental property as a potential win-win: They pick up a new source of income while having a cost-effective vacation destination whenever they have the urge to get away.

It’s easy to understand why vacationers prefer to rent their own property instead of staying in a hotel or condominium, particularly if the property comes at a manageable price for potential buyers.

Many potential buyers are very intrigued by the potential income opportunity of a vacation rental home. Continue reading “Assessing Your Vacation Home’s True Rental Potential”

Tax Planning For Vacation Home Ownership

Owning a vacation home can bring a new level of fun and luxury to your life. It also brings additional complexities to your tax liability, which can impact you both while you own the house and when you plan to sell it. Depending on how you structure your ownership, you could end up having your vacation home add to your overall tax burden.

Interest DeductionTax Planning For Vacation Home Ownership

The IRS allows you to write off the home mortgage interest that you pay on up to two homes.

The rules for your second home are the same as for your first home. For the loan’s interest to be tax deductible, it must be secured by the property.

Depending on your state, this means that the loan should have either a mortgage or a trust deed.

The IRS catch is that it applies the same deduction cap across both of your mortgages. The IRS lets you write off the interest on your first $1 million in home acquisition debt and on your first $100,000 in additional home equity debt.

Home acquisition debt isn’t just the money that you borrow to buy a home. It is also money that you borrow to improve, repair or, remodel a home.  Home equity debt is debt that you take out for any and all purposes.

Remember, though, that the cap applies against both properties. If you have an $800,000 mortgage and a $90,000 equity line on your first home and a $400,000 mortgage and a $60,000 equity line on your second home, you’ll only be able to deduct the interest on half of your second home’s mortgage and only on one-sixth of its equity line.

This happens because $200,000 and $10,000 is all that is left in the home purchase debt and home equity debt caps after your first home’s two loans.

Property Tax Deduction

The IRS is much kinder to you when it comes to deducting property taxes. Your property tax deductions aren’t capped just because a home is a second — or tenth home, for that matter.

You get to write them off along with your personal property taxes or your state income taxes. In this way, second homes have no tax disadvantage when compared to your first home.

Selling Your Vacation House

When you sell your primary home, the IRS lets you exclude the tax liability of $250,000 of the capital gain if single or $500,000 of the gain if married.

So, as a married couple, if you buy for $400,000 and sell for $800,000, you pocket the entire $400,000 with no federal tax liability.

Unfortunately, to qualify for the tax exclusion, you need to have lived in the home as your primary home for two of the past five years. You can also only claim the deduction once every two years.

If you don’t meet these rules, you’ll have to pay the same kind of capital gains taxes on a profitable sale of your vacation home that you would on a stock or bond sale. This strategy can work particularly well for retired couples.

House or Rental?

When your vacation home is a rental property, even part-time, the rules change completely. The IRS allows you to write off all of the home’s expenses to the extent that it is, or will be, used as a rental.

If it’s a rental 90 percent of the time, you can write off 90 percent of the maintenance costs, 90 percent of what you pay for utilities, and 90 percent of your management and advertising costs.

The IRS even lets you claim a portion of its value as depreciation every year, further reducing your tax obligation.

While you can also use the home yourself, if you occupy the home for more than 10 percent of the number of days in a year that it’s rented, you won’t be able to write off any losses that you incur from operating it.

If your vacation home is a rental, you could be eligible for a 1031 exchange. This can allow you to use the proceeds to buy another investment property and defer your capital gains taxes.  However, utilizing a 1031 exchange on a property that you use both as a rental property and as a vacation home for personal use can be tricky, so it’s best to seek professional help in that situation.

Your vacation home can be a ticket to family fun on the beach, at the lake or on the mountain.  Financially savvy homeowners know how to use tax planning to help with the cost of ownership.

Tax liability planning ultimately might be as important to a positive vacation home ownership experience as choosing the right property is!