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This is the first year that I haven’t gone to the beach with my family in 15 years. Traditionally, each year we pack up our cars and trek down south for the six plus hour trip. While I personally don’t love road trips, it’s always worth it when we get to the destination. Inevitably sometime by the middle of the week, we always discuss how amazing it would be to have a beach house. This idea is always met favorably at first. But then reality hits as we factor in costs and expenses associated with a beach rental property.
As amazing as it would be to live by the water, I can’t currently work remotely. Although trust me, I look for that type of flexibility all the time. Since I wouldn’t be able to use that property full-time, I would probably need to rent out the house to gain a passive stream of income. I think a lot of other people would be in the same boat as well.
Rental Properties in OBX
With that said, I began to look into what it would cost to buy a rental property. I specifically looked at rental listings in the Outer Banks (OBX), NC. For those unaware, OBX is a 200 mile long peninsula off the coast of North Carolina with some amazing beaches. Located about five hours from the DC area, this is one of the preferred beach destinations for DC area families.
In OBX, my wife’s family and I really love Corolla, NC. The beaches are incredibly wide, and you can walk for miles. While there may be thousands of people on the beach, you never feel crowded. When I first started to do my research on Corolla, I found that some newer construction with water access costed well over one million dollars.
The property that we stayed at last summer was a 5 bedroom, 5 bathroom home that was about 100 yards from the beach. While we didn’t have an ocean view, it was close enough to hear the Atlantic Ocean at a distance. Built in 1988, its tax-assessed value was around $422,000. While this property wasn’t for sale, I thought the assessment of $422,000 for this property seemed pretty reasonable, especially comparing that price to other homes for sale in Corolla.
Generally speaking, in North Carolina the typical rental season is between 15-20 weeks. The majority of rentals occurs in June, July, August and September. The peak season is roughly eight weeks long. During these eight weeks, this $422,000 property can normally fetch $4,000 a week or $32,000 over the peak season. The remaining twelve weeks normally receive between $1,500 for offseason to $2,500 for the shoulder season. If we calculated that there were an additional 8 weeks of shoulder season and four weeks of offseason, the property would receive an additional $26,000, for a total of $58,000.
Expenses Associated with Renting a Property
With that said, thanks to the Great Recession, lending standards are more stringent than ever. To receive the most favorable interest rates, down payments must meet or exceed 20%. This would mean that I would have to place a down payment of at least $85,000 in order to even potentially qualify for a beach house.
For this example, let’s say that I qualified for a $337,000 mortgage to cover the remaining 80%. This would equate to a roughly $1,528 monthly mortgage payment, based on a 4%, 30-year fixed interest. Right off the bat, $1,528 doesn’t sound too bad, but I haven’t included any of the other fees.
Insurance in a beach town costs more than a regular property. It amounts to somewhere around 2% of the value of the home. This is due to all the additional coverage that a homeowner needs such as flood insurance, homeowners/hazard insurance, wind insurance and liability insurance. Based on this, insurance would amount to about $8,500 for this beach house.
Property taxes in Currituck County, where Corolla is located, averages around $0.50 per $100 or 0.5%. This means that a million dollar property would be responsible to pay $2,100 in real estate taxes.
Home maintenance for homes normally runs 1% of the home value, for about $4,000. While you may not spend the whole amount each year, over time when the appliances, roofs and carpets need to be replaced, you’ll be thankful you have the money set aside.
A property manager would be needed for those that live out of town and are not interested in fixing a toilet in the middle of the night. Property managers are available, but their fees are normally between 15%-22% of the rent price.
On top of that, many out-of-town owners need to set up contracts with HVAC service and repair, pest control services, and carpet cleaning services to name a few. This would run between $1,500-$2,500 a year depending on whether there is also a pool and/or hot tub.
You would have to put work into the beach house to keep it up-to-date. Beach goers don’t want to walk into a time capsule from the 1970’s. You would need to replace art work, bedding and even curtains every five years or so. No one wants to look at stained bedding and faded curtains, so add another $1,000 a year.
In the chart below, I have summarized Income and Expenses. As you can see, a homeowner you will potentially have a positive cash flow each year close $18,000 with this example of a beach house if you manage it on your own. If a property manager is utilized, there would be a positive cash flow of $7,000. These are under the assumptions that you are able to rent out every week during peak season, along with the shoulder season, and then get an additional month with snow birds. While this may seem aggressive, it looks like with some positive marketing, that it is possible to eek out a profit.
|Property Management Fee||–||11,200.00|
Another expense you can claim on your Schedule E is rental depreciation. This depreciation only applies to the value of the home or any building structures (e.g. pool). The land value CANNOT be included in this depreciation. For example, let’s say you bought a rental home for $400,000, with land worth $100,000 and home structure worth $300,000. Per rental home IRS guidelines, you would only be able to depreciate the house value at $300,000, divided by 27.5 years. So each year, you would be able to deduct roughly $11,000 on your Schedule E for this particular property.
One thing that most people don’t realize is if you choose to rent out the vacation home while also using it for personal use, there are limitations to the expenses that you can deduct on the property. According to IRS regulations, “You are considered to use a dwelling unit as a personal residence if you use it for personal purposes during the tax year for more than the greater of:
- 14 days, or
- 10% of the total days you rent it to others at a fair rental price.
Personal Use of Property
So, that means that the maximum number of days that you could reside in the home is 33 days total. In that case, you would have to rent out the property at fair market value for the remaining 330 days. This is obviously a high bar to meet, since often times there is a week or two throughout the year that a beach house is probably not rented.
If you reside more than 14 days or more than 10% of the total days that you rented, the property would be considered personal in use. Thus, you would no longer be able to claim expenses if they exceed the amount of income received throughout the year.
Deduction Limitations Due to Income
With that said, let’s make the assumption that you will only utilize the beach house for two weeks. Great news, you’ll be able to deduct in full your rental expenses on your Schedule E up to $25,000. Now, here is the bad news. If your modified adjusted gross income exceeds $100,000, the expenses begin to get phased out until they reach $150,000, when the allowance is no longer allowed. That means if you make more than $150,000, that you can no longer deduct losses on your current year taxes.
While beach rental property situation sounds amazing in principle, as you can see above, you must be able to buy it at the right price in order for you to get the return on investment that is profitable.
Have you bought a beach rental? Has the property worked out for you, or is it a money pit? Share your thoughts below.