Making the most of vacation homes

Here’s a know-your-clients question. How many of your clients own vacation homes? If you were to add up all the cottages, condos and time shares, you might be surprised at the extent of second home ownership. Indeed, the value of vacation homes in Canada seems to have exploded over the past decade. Statistics Canada, which has periodically measured Canadians’ net worth for half a century reports a spike in the value of secondary real estate since 1999.

In its most recent Survey of Financial Security (2005), StatsCan found that 16% of households, some 2.1 million families, owned secondary properties such as cottages and second homes. In six years, the value of these properties had risen by more than 80% to $481 billion, the largest growth rate for any personal asset class. The historically low interest rates and generally positive economic conditions behind this growth continued through most of the rest of the decade, so it’s not unreasonable to assume that the level of vacation property ownership has remained stable or is perhaps even higher today.

This phenomenon can provide an opportunity to broaden and deepen your relationship with clients who own second homes. Those who are younger – the average age of a second home owner is in the early 50s – will likely use these homes extensively, especially if they have children. But almost three quarters of all second homes are owned by childless couples or seniors who might value the suggestion that they rent them out.

The revenue potential can be considerable. This summer, higher end cottages – three bedrooms or more – in Prince Edward Island’s Prince Region will ask $1,600 a week, in Quebec’s Laurentides Region $1,850, and in Ontario’s Muskoka or on Vancouver Island, roughly $2,000.

By familiarizing yourself with the tax and other considerations involved in renting vacation properties, you can help your clients make their homes away from home financially productive as well as enjoyable.

A cottage case study

To illustrate, let’s look at the example of a semi-retired couple whose children are now in their early to mid-twenties. The parents are long-time cottage owners but they’re now more interested in extended travel than lazing on the dock. And their kids are too busy establishing careers to spend much time at the cottage. By renting the cottage out for the long stretches of summer when the family won’t be around, our couple can achieve two important objectives: they’ll have the comfort of knowing the cottage is occupied during the busiest period of the year when it might otherwise be a target for theft or vandalism; and it will generate rental revenue to help offset the cost of maintenance, property insurance and local taxes. And as we’ll see, this second goal can be accomplished in a tax-effective manner.

Getting ready to rent

If your clients have never rented their vacation property before, they’ll need to know some of the steps that need to be taken to ensure peace of mind. For starters, how will they advertise the property – in publications, on the Web, or simply by word of mouth? In the latter case, personal contacts may make it easier to assure trustworthy tenants. Clients will want to check their property insurance policies to ensure rental situations are covered. For instance, will the policy cover any damage caused during a rental, either through malice or vandalism? Again, this underlines the importance of having trustworthy tenants.

How will regular or emergency maintenance be handled while the owners are not around? Can they rely on a trusted friend, neighbour or local handyman, or do they require a more arm’s length professional arrangement? If they go the latter route, your clients will likely pay more, but they will have greater certainty the maintenance will be done to professional standards.

One way around most of these issues is to hire a property manager, and preferably one familiar with local rental rates and quality service providers. Clients should fully understand the property manager’s fee structure and be ensured that the manager is capable, based on references from property owners who have used them.

Taking care of basics

Clients will want to arrange a major cleaning of the cottage at the beginning of the season as well as regular cleanups before new renters arrive. They will want to remove personal items or objects of significant value as well as consider child-proofing the cottage in case of rentals to families with younger children. It’s also a good idea to arrange to have someone in the area check in on the cottage and its occupants on a regular basis.

Accounting for rental income

The figure that matters for tax purposes is net rental income. This is the amount that will be included in the income column on a client’s income tax return.

Figuring it out takes a bit of work, however. Net rental income is revenue less expenses. Revenue in this case is simply the gross rent that’s collected. The expenses figure is more complicated since it includes both direct and indirect costs. The former category includes items directly related to the rental process such as advertising, cleaning, property management fees, and renters insurance. The latter includes expenses made regardless of rentals, including general insurance coverage, repairs and maintenance, property taxes, utilities, mortgage insurance, cottage association, and road maintenance fees. Expenses for these indirect items would be allocated in proportion to the period the property is available for rent.

Being businesslike

As in any exercise that has tax implications, you should advise clients to keep thorough records. They would also be well advised to seek professional help. For example, they will probably need an accountant to compute expenses. It would also be worth pointing out that occasionally renting out the family cottage is significantly different than the purchase of a cottage as an investment with the intention of renting it to make money. The financial analysis of such an investment is much more complicated.

It’s about more than money

Periodic cottage rentals will probably not make your clients rich. In my experience, owners typically end up with sufficient gross rental revenue to offset expenses, leaving a small amount of net rental income that will add to their taxable income. Of course, if expenses surpass rental income, there will be a rental loss which normally can be deducted against other income.

But strictly speaking, renting a vacation property is not about making a profit. You can point out to clients that simply by generating revenue that offsets the cost of operating a second property, they free up other income. And by keeping a property occupied and secure in periods when it would otherwise be vacant and potentially vulnerable, they are helping to preserve the value of their investment.