Permanent Vacation

Recently, he made an offer on a vine-covered stone house in California's wine country. It's just down the road in tony Yountville from the hot restaurant French Laundry, and Thompson, a divorced dad from Orinda, Calif., has it all worked out in his head. Once a week he'll head out to the house with clients or his two grown daughters, and together they'll decompress in Napa Valley. "It's a nice little getaway," he says. "I just said to myself, 'What the hell?'"

Weekend homes used to be, well, a luxury. But these days, thanks to everything from those historically low interest rates to a whole new mentality about taking vacations, they're becoming the latest status symbol for middle-class America. According to the National Association of Realtors, last year set an all-time record for second-home sales, hitting 445,000, or about 5 to 6% of all home sales. Prices were all over the place, from grand multimillion-dollar beach houses in East Hampton to $200,000 cabins in the Wisconsin forests. And so far, the market has remained strong even with rates nudging up a bit, turning a host of towns you may not have heard of (Alta, Utah? Crested Butte, Colo.?) into hot spots in their own right.

Brokers say this is only the beginning of the second-home march, and to be sure, the demographics are on their side. The nation, as everyone knows, is getting older, and that means the largest pool of second-home buyers — retireesis only getting bigger. In the year 2011 almost 4 million Americans are expected to turn 65, a 73% increase over the number who reached that birthday in 2001, according to U.S. Census data. Christopher Cain, author of Road Map to Your Vacation Property Dream, says this group is already driving beachfront property through the roof because many aren't waiting for retirement. "Every year it's a relentless wave of baby boomers entering the second-home market," he says. "And it's just going to continue."

What's more, vacation homes are to some extent in limited supply; usually, they're situated amid beachfront towns or mountain resorts, and places like these can handle only so much expansion. "God's not creating many more scenic vistas," says Walter Molony, a spokesperson for the National Association of Realtors. The bottom line: Even with prices high, now may be a good time to move into double-home ownership before it's too late.

But how do you get into this market, and what's the best way to buy? As with any real estate purchase, a vacation home can be a fount of not-so-fond memories, including property taxes, insurance, maintenance costs and property-management fees. Renting it out? Additional problems of upkeep, income reporting and finding tenants come into play. Indeed, unlike with your primary home, you have many options when you buy a second home — which we've condensed into four. Follow along closely and who knows — maybe you'll find yourself sitting as pretty as Clark Thompson. "Most people say it's the best thing they ever did," he says.

Option One
Buy It, Use It Yourself
Naturally, the best option for a vacation home is to buy it and just use it yourself. In fact, according to an NAR survey, 71% of all second-home owners don't rent out at all. Sure, you have no rental income to help with the mortgage, but you also have none of the worries and hassle of dealing with tenants and extra taxes. And of course, there's the best reason of all: You and your family get to be at the house whenever you want, for as long as you want.

"I bought it primarily for myself and my family," says Dan Peterson, the 49-year-old president of an employee-benefits consulting firm, about his three-bedroom townhouse villa in the Florida Keys. His daughter, he says, just graduated from Duke University, and Peterson is expecting her and his wife, Becky, to make it there most weekends. Besides, Peterson, who thought about renting, has also discovered that giving up potential rental income isn't that hard when you consider how second homes are appreciating.

Indeed, by all accounts, the vacation home market has been every bit as strong as the general housing market. Prices were up in the past year everywhere from the Hamptons (26%) to Reno, Nev. (13%), to the Cape May, N.J. area (16%). With values up, even prime-season rents can seem small-or at least they did when Peterson did the math. At best, he figures he could occasionally get $2,200 a week for a home he recently put on the market for $975,000, or 48% more than he paid for it, including $100,000 in improvements. Does he really want to expose such a valuable asset to an anonymous renter? "The idea of renting it out to an unknown, the risk is just too great," he says.

Option Two
Buy It, Rent Short Term
Okay, much as you'd love to, you just can't swing that Aspen retreat and bear the full mortgage yourself. Renting it out for short periods is an obvious solution, and here's the good news: The same forces that are escalating second-home prices — i.e., an affluent and aging baby boomer population — are also beginning to push up the rental rates that had fallen in the post-9/11 era. How much? About 3 to 5% nationally last year, according to EscapeHomes.com, and more in some hot spots such as Cape Cod, Nantucket and Hawaii, where even the off-season is becoming strong.

For Charlie Kesler, a healthy rental market has made all the difference in the world. The Madison, Wis., sales manager and his wife have owned a cottage near Shawano Lake for 11 years now and in the past nine years have seen the weekly rental jump 75%, from $400 a week to $700. This, for a cottage whose property taxes are only $2,100 a year. He could get more, Kesler says, but he sticks to a basic renting principle of his — be picky about the tenants you choose. "We only rent to people we know," says the father of three.

So what are the issues to think about? For starters, of course, there are tax concerns, beginning with the length of the rental. According to Linda Goold, tax counsel for the NAR, Uncle Sam actually allows second-homeowners to rent out for less than two weeks without declaring any extra income. But go beyond those two weeks and you'll probably need an accountant to figure out income and deductions (skip ahead to option three for more details). Want to take the full standard mortgage-interest and property-tax deduction? Goold says you can apply it against your personal income if the rental doesn't exceed two weeks, but you have to apply a portion of it against rental income if it does.

And don't forget all the other issues that come with renting, like the added liability. Liability premiums can be "a little" higher if you have a constant stream of renters, says Jeanne Salvatore, vice president of consumer affairs for the Insurance Information Institute, but "are worth it." Her suggestion: Get covered over and above your basic policy, especially if you have a lot to lose. And consider a higher level of no-fault medical coverage too, which allows renters to deal with insurers directly instead of suing the homeowner.