Owning a Vacation Rental: Lessons Learned

Eight years ago, I fulfilled my lifelong dream of purchasing a quaint old property in need of restoration and repair. The Anchorage, built in 1812, had been a summer home for five generations before I bought it. I have Edwardian-era photos of the previous owners sitting on the front porch of the house before they added two additional wings, a dormer, and three more bedrooms to the place. 

I have an affinity for money pits and this place is a doozy: Two houses, a decent-sized barn, two springs with deep-well cisterns, and 27 acres of land. That the place was cheap enough for a freelance writer without a trust fund to purchase outright, speaks volumes about the energy and additional cash I’d need to make improvements and do yearly maintenance. My friends and elderly parents begged me not to buy the place.

But where everyone else saw problems, I saw opportunity. I could rent the front house and live in the Adirondack-style cabin set farther back in the woods. I had plenty of water and it is an area that will be minimally impacted by climate change. The family had been conscientious about repairing the Anchorage even as they allowed the back cabin to sink into a marsh. It came fully furnished with all the linens and dishware. Most importantly, it was in a prime location for summer rentals, complete with water views on coastal Maine.

I started renting the Anchorage seven summers ago and there has been a steep learning curve. If you are thinking about purchasing a vacation rental yourself, here are some of my takeaways.

Pros of Owning a Vacation Rental

It Can Be a Decent Tax Shelter

The IRS allows you to offset your ordinary income with losses of up to $25,000 a year from investment property (phased out for adjusted gross incomes between $100,000 and $150,000). In a nutshell, here’s how the accounting works: Money you bring in (e.g. rental income) is considered income, but you can offset that by deducting the expenses of owning and maintaining the property (e.g. mortgage interest, insurance, utilities). You are also allowed an annual deduction for depreciation — one of the best tax perks for rental real estate owners. If your rental property expenses plus your depreciation allowance exceed your rental property income, you’ve generated a passive loss that year for tax purposes — something that is especially easy to do in the early years of ownership. If you can't make use of the full loss in one year, the balance can be carried forward for use in later years. (Here’s a good article for strategies to make use of suspended passive losses.) It goes without saying that the tax rules around rental real estate are complicated, and your participation and use of the property will impact its taxation, so the other takeaway is that securing a knowledgeable accountant is highly advisable.

You Get a Bigger Bang for the Buck Over Other Investments

A real estate broker explained this to me succinctly: Say you pay $250,000 for a rental property and sink another $150,000 into it. Earning interest at a rate of 4%, that $400,000 would yield $16,000 in income per year when invested in CDs, all of it taxable. 

Your vacation property, on the other hand, has the potential to yield the same amount in cash flow through the rents coming in during the season, and if you hustle, you may have the potential to earn much more. You can also raise your rents to adjust for inflation — something you have little control over with cash investments. 

If that’s not good enough, every day you own the property you are building equity on top of the original purchase price. That’s the great thing about real estate investment. You have the potential for cash flow and capital appreciation. 

You Have a Tax-Free Option for Building Wealth 

Last summer, after selling my primary residence, I looked into selling the Anchorage as well and upgrading to a multi-family property in Providence, Rhode Island. After a few years, I would live in one unit, use the second to pay my property tax and maintenance, and pocket cash flow from the third. 

Although I later changed my mind, this plan could have been executed tax-free thanks to a provision in the Internal Revenue Code commonly known as a “like-kind exchange.” The rule allows you to sell an investment property and defer any capital gains tax as long as you trade into a property of equal or greater value (and meet some stringent timing requirements).

The “like-kind” designation is a bit misleading — you can purchase diverse kinds of real estate through a 1031 exchange, including raw land. You can even trade into two or more properties, allowing you to expand your investment portfolio. 

Cons of Owning a Vacation Rental

You Really Need To Hustle To Make Bank  

I write marketing copy for a living, so the last thing I wanted to do was make a branded website in my spare time. Nor did I feel up to turning my place into a site for destination weddings, glamping, or an academic summer camp — all ideas to maximize cash flow that I’ve toyed with over the years. 

If I were willing to devote time to marketing and finding the perfect niche, I could definitely turn a bigger profit on the place, but because that is an unwarranted hassle for me, I am content to use short-term rental platforms. I funnel all the income into expenses but get to live with low taxes and a free roof over my head — and as long as I am working on the place, the IRS allows me to treat the entire place as an investment property rather than a primary residence. (This is the same tax loophole people employ when they live in houses while they are flipping them.) 

For someone with an entrepreneurial mindset and practical skills, the right property can be an excellent source of income. But you have to be very careful where you buy. More and more communities are deciding not to allow vacation homes to be used as short-term rentals. 

In others, you will have to petition the town to convert your property into a seasonal business even if it has no zoning laws. Where I live, the board of selectmen refused to allow new owners to turn a rundown storefront into a tea house, perhaps because the mother of someone on the board owns a similar business right down the street.

People Can Be Problematic

I’ve had argumentative and unskilled workmen over the years, and post-COVID labor shortages make even finding tradesfolk to work on the place problematic. And of course, as a single woman, I’ve had my share of workmen attempt to bamboozle and overcharge me.

I’ve also had difficult guests. One swore that he got bedbugs in my house and wanted me to pay for all new bed linens at his place back home. I had to get a letter from an exterminator stating the house was pest-free! Another wanted to back out of a month’s stay on the second day because she had been invited to stay elsewhere for free. A third woke up the whole village at 3 a.m. playing loud music, something my neighbors still complain about.

You can use a management company to create a buffer zone between you and renters or maintenance folks, but you will lose both a percentage of your profit — rental agencies take anywhere from 15% to 30%, depending on what services they provide — and control over how you resolve issues and communicate with renters.

Unforeseen Events Will Cut Into Your Return On Investment

It is naive to buy a vacation property thinking it will be smooth sailing. Roofs need replacing, septic systems overflow, clapboards rot, and a good rain can wash out your entire driveway. Even a new property can succumb to extreme climate change events or problems due to faulty workmanship. 

Some years everyone will be vacationing, other years people stay home. Since COVID disrupted the supply chain, the price of building materials skyrocketed, making repairs more costly. War and civil upheaval, wildfire smoke, a family of skunks living under the house — all can render your property unusable for periods of time.   

You can seek to minimize the damage, but there’s no way to avoid it altogether, and a long enough stretch of bad luck could cause you to sell at a loss. 

A Final Word to the Wise

Location is everything in real estate. It’s a cliché, but it’s true. 

You’re better off buying a mediocre vacation rental property in a great location than a great property in an unlovely spot. Only property in a prime location appreciates with any consistency over time, and because your place will be desirable to more renters due to where it is, the potential for positive cash flow is greater. 

The impact of climate change is now another factor you need to take into consideration when you purchase a vacation rental property, along with proximity to tourist attractions, local codes and zoning laws, and the condition of the property itself. 

A real estate writer for years, I can’t say I was exactly naive when I bought my vacation property. The country was still in a recession and the place had been on the market for years alongside many other rundown old properties in the area. I knew I was getting a bargain — one that has already paid off. Last summer, I turned down an offer on the place that would have landed me a sweet profit. All things considered, it’s been worth all the frustration of being a landlord to know that the payout will be there to fund my retirement and any future adventures I wish to take.