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My wife and I love going to the beach. The sand between our toes, the sound of the crashing waves, and the smell of the ocean air invigorate us. Every year, my wife and I dream about moving down to the beach and forgetting about our busy lives in the DC area. Admittedly, the allure of leaving our area and living down at the beach full-time sounds better and better every year.
However, then reality sets in. I remember that I can’t telecommute for work and that we would miss out on living close to family. Speaking of family, our families completely disagree on where the best beaches are.
My In-Laws think that the best beaches are found in the Caribbean. Meanwhile, my parents love Sunset Beach in North Carolina, which was voted by National Geographic as one of the greatest beaches in the world. On the other hand, my wife and I are partial to the Outer Banks (OBX), also in North Carolina. We like it mostly because of its proximity to us. Any longer than 5 hours of driving results in Pterodactyl screams from our children. It’s like being trapped in Jurassic Park.
As much as I would be to live at the beach year round, since we couldn’t use that property full-time, my wife and I have thought about buying and renting out a beach house as a passive stream of income.
We have had some friends who have done it over the years. While it sounds great in theory, I know that they experienced some hiccups along the way.
Rental Properties in the Outer Banks
While we were down at the beach recently, I began to look into what it would cost to buy a rental property.
For those not familiar with OBX, it is a 200-mile long peninsula off the coast of North Carolina. It has some of the best beaches north of Florida. OBX is about 4-6 hours from the DC area (depending on traffic or how many times you have to stop due to unhappy kids). In the summer down there, I feel like I see more Virginia and Maryland license plates than North Carolina ones.
My wife and I stayed in Nags Head this past vacation. We really loved it. The beaches were clean, there is a great new playground for the kiddos, and there is delicious food all around. Overall, Nags Head has a really nice family atmosphere.
The property that we stayed at this summer was a 3 bedroom, 2 bathroom home. It was about 100 yards from the beach. While we had a very slight ocean view when we stood at the perfect angle on the top deck, we could hear the ocean in the distance. Built in 1986, its tax-assessed value was around $524,000. While this property wasn’t for sale, I thought the assessment of $524,000 for this property seemed pretty reasonable in comparison to others in the area.
So I thought today, I’d run through the numbers to see if buying that beach house would be a good idea.
In general, the Outer Banks rental season is typically between 15-20 weeks. The majority of beach rentals occur in June, July, August and September with peak pricing lasting roughly 8 weeks long.
During these 8 weeks, this $524,000 property can normally fetch $5,000 a week or $40,000 over the peak season. The remaining 12 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 4 weeks of offseason, the property would receive an additional $26,000, for a total of $66,000 per year.
Expenses Associated with Renting a Property
Mortgage standards are more stringent than ever due to the Great Recession, although they seem to be loosening up recently. My wife and I are lucky to have FICO scores of 800+. In order to receive the most favorable interest rates, we would need to put a down payment of at least 20%. This translates to a down payment of at least $105,000 in order to even potentially qualify for this particular beach house.
For this example, let’s say that I qualified for a $419,000 mortgage to cover the remaining 80%. This would equate to a $2,154 monthly mortgage payment, based on a 4.625%, 30-year fixed interest. Right off the bat, $2,154 doesn’t sound too bad, but I haven’t included any of the other fees.
Insurance in a beach town routinely costs more than a regular property. From my research, insurance routinely costs somewhere around 2% of the assessed 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 $10,500 for this beach house.
Property taxes in Dare County, where Nags Head is located, costs $0.697 per $100 or 0.697%. This means that this $524,000 property would owe $3,652 in real estate taxes.
I’m going to go a bit conservative and say that the home maintenance for beach rental will normally run 1% of the home value, or about $5,000 in this case. While you may not need to spend the whole amount each year, because of wear and tear, appliances, carpets, and roofs will eventually need replacing.
If you don’t plan to live close to the rental property, you’ll probably need a property manager. Even if you do live close by, you may not be interested in receiving late night phone calls about issues like a broken toilet. Property management fees are normally between 15%-22% of the rent price.
On top of that, many out-of-town owners decide to set up contracts with HVAC service and repair, pest control services, and carpet cleaning services, to name a few. This can run between $1,500-$2,500 per year, depending on whether there is also a pool and/or hot tub.
If you’re like me, it’s nice walking into a beach house that is kept up-to-date. I’m definitely not a fan of beach houses that look like the owner hasn’t touched it since the 1980’s. It’s important to ensure that artwork is appropriate, the bedding is still in good shape, and the curtains still look good, so add another $1,000 a year.
In the chart below, I have summarized Income and Expenses when it comes to the beach house.
|Property Management Fee||–||$14,520.00|
As you can see, if you manage the property on your own, you could have a positive cash flow each year around $16,000 in this specific example. If you use a property manager, you would receive a measly $2,000 at best. And, these are under the huge assumptions that you are able to rent the beach house property 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, it may be possible to eek out a small profit, but it would be tight.
While this doesn’t show up in your cash flow analysis, another expense you can claim on your Schedule E is rental depreciation. Rental 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 $524,000, with land worth $100,000 and home structure worth $424,000. Per rental home IRS guidelines, you would only be able to depreciate the house value at $424,000, divided by 27.5 years. So each year, you would be able to deduct roughly $15,418 on your Schedule E for this particular property.
There’s an aspect of renting out a beach house that most people don’t realize. 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
That means that the maximum number of days that you and your family could reside in the home is a total of 33 days. In that scenario, you would have to rent out the property at fair market value for the remaining 330 days. I don’t know about you, but that is an incredibly high bar to meet for a rental property. Oftentimes, there is a week or two throughout the year that a beach house probably goes unrented, like during Thanksgiving or Christmas time.
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.
So much for using your beach property when it’s not being rented.
Deduction Limitations Due to Income
Let’s make the assumption that you follow the letter of the law and only utilize the beach house for two weeks. Great news: you’ll be able to deduct 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 for the beach house begin to get phased out until they reach $150,000, when the allowance is no longer allowed. So, if you make more than $150,000, you can no longer deduct losses on your current year’s taxes.
While a beach rental property situation sounds amazing in principle, I realized that I’d really need to buy at a very low price in order to receive a substantial profit.