The Beach Rental That Cut Taxes and Lost Money: A 15-Year Case Study

A couple bought a beach cottage in a Southeast coastal town in the summer of 2005 and rented it out through a local agency. They sold it fifteen years later, in the summer of 2020. The part of the story they tell is the tax return: in the year they sold, with their salaries as high as they had ever been, their federal tax bill fell by tens of thousands of dollars.

That part is true, and the tax code produces it on purpose. It is also the last entry in a fifteen-year record of losing money. This case study puts the tax return next to the other two ledgers, what the cash did and what the money could have done instead, using the real price history of one house.

The short version

The house sold for about $250,000 after being bought for about $240,000, a price gain of 0.3% a year over fifteen years. Under our modeled operating costs it lost about $12,400 in cash every year, and because the owners earned over $250,000, every dollar of the loss was suspended until the sale. The sale released about $253,000 of losses at once and cut that year’s federal tax, for a modeled $300,000 W-2 household, from $54,207 to $9,877. After that tax benefit the owners were still about $148,000 behind where they started in nominal dollars, and about $650,000 behind the same money in a global index fund after tax. The next owner sold the same house five years later for about $470,000. Over the full twenty years the house tracked its regional price index almost exactly. The difference between the two owners was when each one bought.

The record

The sale prices come from county deed records and MLS data. We have rounded them and left out the location, the owners, and anything else that identifies the property. The operating costs and the owners’ income below are modeled, and each assumption is stated where it is used.

Sale	Price	Held	Price change per year
Mid-2005, to our owners	$240,000
Summer 2020, to the next owner	$250,000	15.1 years	+0.3%
Late 2025, to a third owner	$470,000	5.3 years	+12.6%

Same house, same beach, two owners, and returns of 0.3% and 12.6% a year. We will come back to why.

What it cost to hold

The rental was thin. After the agency’s commission and cleaning fees, rent netted less than the property tax bill. Everything else, insurance, the association fee, utilities, and upkeep, came out of the owners’ pockets. We assume the house was bought for cash and that it qualified as a rental under the tax rules, which means family use stayed under the greater of 14 days or 10% of the days it was rented.¹

Modeled, per year	Amount
Rent, after agency and cleaning fees	+$2,500
Property tax	−$3,000
Insurance	−$2,500
Association fee	−$5,000
Utilities	−$2,000
Repairs and upkeep (1% of price)	−$2,400
Cash lost each year	−$12,400
Depreciation (half the price is building, over 27.5 years)	−$4,364
Tax loss each year	−$16,764

The cash drain was 5.2% of the purchase price every year. To break even before counting any alternative use of the money, the house needed to appreciate about 5% a year. It appreciated 0.3%.

Why the sale year produced the tax break

A rental loss is passive, and passive losses can offset only passive income. The exception is a special allowance of up to $25,000 for owners who actively participate, which shrinks by 50 cents for every dollar of modified AGI above $100,000 and is gone at $150,000.² Our owners earned more than $250,000 in every year, so none of their losses reduced their tax while they owned the house. Each year’s loss was suspended and carried forward.

The rules release that stockpile when the property is sold. Suspended losses “are generally allowed in full in the tax year in which you dispose of your entire interest” in a fully taxable sale to an unrelated buyer.² Fifteen years of losses arrived on one return, as ordinary deductions against wages.

The sale itself produced a taxable gain, even though the price barely moved. Depreciation lowers the cost basis whether or not the property loses value, so the basis had fallen from $240,000 to about $174,000. Net of a 6% commission, the $250,000 sale produced a gain of about $60,800, all of it recaptured depreciation taxed at no more than 25%.³

Here is the 2020 return for a modeled couple with $300,000 of wages, filing jointly and taking the standard deduction, using that year’s brackets.⁴

2020	No sale	With the sale
Wages	$300,000	$300,000
Released rental losses		−$252,900
Gain on the sale		+$60,800
Taxable income	$275,200	$83,167
Federal income tax	$54,207	$9,877

The tax bill dropped by $44,330. The released losses came off income that would have been taxed at 24%, and the gain, which could have been taxed at up to 25%, landed in the 12% and 22% brackets instead. By the letter of the law, everything here is correct, and the story the owners tell is accurate.

The same fifteen years in cash

The tax return shows one year. The owners’ bank accounts show fifteen.

Purchase	−$240,000
Operating losses, mid-2005 to mid-2020	−$187,000
Sale, after a 6% commission	+$235,000
2020 tax reduction	+$44,330
Net, in nominal dollars	−$147,700

Every dollar of the tax break came from money already spent. The released losses were $187,000 of real cash plus $65,800 of depreciation, and the deduction returned about 18 cents on each of those dollars, fifteen years late and without interest.

Here the depreciation matched a real loss of value. Consumer prices rose about a third between 2005 and 2020, so the $240,000 paid in 2005 was worth about $318,000 in 2020 dollars.⁵ A building that sells for $250,000 after that has lost real value, and the tax deduction for its wear roughly matched what happened to it. This is the reverse of the usual rental pitch, in which depreciation shelters income on a property that is going up in value. We walked through that version in what a rental write-off is actually worth.

What the same money would have done

The fair comparison puts the same dollars, at the same dates, into something else: $240,000 in mid-2005, plus $1,033 at the end of every month the house was losing money, valued at the end of August 2020. The alternatives pay tax along the way on dividends and interest, and on the remaining gain when sold. The house keeps its $44,330 tax break.

Alternative	Return per year	After-tax value, Aug 2020	House behind by
VTI, U.S. total stock market	9.7%	$1,248,000	$969,000
VT, global stock market	7.4%	$932,000	$652,000
60% VT, 40% BND	6.5%	$814,000	$535,000
BND, U.S. investment-grade bonds	4.3%	$614,000	$335,000
One-month Treasury bills	1.2%	$466,000	$187,000
Cash earning nothing	0%	$427,000	$148,000
The beach rental		$279,000

Method: Vanguard fund total returns from dividend-adjusted monthly closes, July 2005 to August 2020.⁶ VT launched in June 2008; before that we use a monthly-rebalanced 45% VTI, 55% Vanguard Total International Stock Index Fund blend. BND launched in April 2007; before that we use the Vanguard Total Bond Market Index Fund. T-bills are the one-month Treasury series from the Ken French Data Library.⁷ Taxes on the alternatives: dividend yields of about 2% on stock funds taxed at 15%, bond and bill income at 33% (32% from 2018), the 3.8% net investment income tax from 2013, and the remaining gain taxed at 18.8% at the end. No state tax on either side. Past returns do not predict future returns.

The stock rows depend on a good fifteen years for U.S. equities, and a reader can reasonably discount them. The bottom rows do not depend on anything. Treasury bills, the lowest-risk asset available, finished $187,000 ahead, and leaving the money in a checking account at zero interest would have beaten the house by $148,000. The house lost money outright, before any comparison with stocks.

Why the next owner nearly doubled it

The next owner bought the same house in 2020 for about $250,000 and sold it in late 2025 for about $470,000. Nothing in the record suggests they were better at real estate. The chart shows what they had that our owners did not: a different starting date.

The blue line is the Federal Housing Finance Agency’s house price index for the South Atlantic census division, scaled to start at the $240,000 purchase.⁸ Three things stand out.

Our owners bought eighteen months before the top. Regional prices peaked in the first quarter of 2007, fell 26% by mid-2012, and did not get back to that peak until the second quarter of 2018. Over the fifteen years our owners held the house, the regional index rose 1.5% a year.
The house did worse than the region going down and better going up. Beach cottages are second homes, a purchase people drop first in a recession and add first in a boom. The house trailed the index through 2020 and then outran it: from 2020 to 2025 the region rose 9.4% a year and the house 12.6%.
The next owner bought at a moment built for the trade. The average 30-year mortgage rate was 5.70% when our owners bought and 2.94% in August 2020, and it set its all-time low of 2.65% in January 2021.⁹ Remote work and the short-term rental boom pushed demand for coastal second homes up at the same time.

Over the full stretch from mid-2005 to late 2025, the house rose by a factor of 1.96 and the regional index by 2.01. The house was an ordinary regional asset. One owner held it through the worst fifteen years of the cycle and the next held it through the best five. We cannot see whether the next owner renovated, which would move some of their gain from appreciation to money spent, or what the house earned in rent after 2020.

A second house, bought in the early 1990s

The same owners’ primary residence tells a quieter version of the same story. They bought it in the early 1990s for about $235,000, and an automated estimate puts it near $440,000 today. That is about 1.8% a year in price, below inflation over the period, while the regional index rose about 4.4% a year.⁸

A home you live in cannot be judged on price alone, because most of its return arrives as rent you do not pay. The same automated service puts market rent for this house near $2,550 a month, about 7% of its estimated value before costs and roughly 5% after property tax, insurance, and upkeep. Price plus avoided rent comes out in the middle single digits, closer to a balanced fund than to a stock index. We worked a primary home through this full calculation in did buying this house beat renting?

These owners also paid the mortgage off within six years. Thirty-year rates averaged between 7.3% and 10.1% from 1990 to 1994, so each extra payment earned the loan’s rate, somewhere in that range, with no risk.⁹ The S&P 500 returned about 21% a year from 1993 through 1998,¹⁰ so in hindsight the payoff was expensive. At the time it was a guaranteed high single-digit return, and no one knew what the late 1990s would bring. We weigh that trade in do you need a paid-off home to retire?

What this says about real estate as an investment

One house is one bet with one entry date. The same property returned 0.3% a year to one owner and 12.6% to the next. A stock index fund bought in mid-2005 had the same bad timing and still compounded, because the companies inside it kept earning. A house that rents at a loss has only its price to rely on.
Carrying costs are a return you pay every year. At 5.2% of the price annually, this house needed a boom just to break even. Before you buy, add up tax, insurance, association fees, and upkeep against realistic net rent.
The price you pay matters for houses too. Buying near the top of a regional bubble cost these owners fifteen years. Prices relative to rents and incomes carry the same information for houses that valuations carry for stocks.
A deferred deduction is paid for in advance. The sale-year tax break was real, and it was fifteen years of losses returned at a fraction of their cost. We covered the general case in tax losses can be valuable, losing money isn’t.
Stories about one house select their dates.“This cottage nearly doubled in five years” and “this cottage went nowhere in fifteen” are both true of the same building.

When a second home is still worth buying

A beach house can still make sense when you price it as what it is.

You will use it. A second home you visit for many weeks a year is consumption, like travel. Compare its annual cost with what renting similar weeks would cost. Heavy personal use also takes it out of the rental rules this case assumed, so the tax picture changes.
The rent covers the costs. A property whose net rent exceeds tax, insurance, fees, and upkeep does not need appreciation to work. This one never came close.
You can carry it through a bad decade. These owners could. Owners who could not would have faced selling near the 2012 bottom.
It is a small part of your net worth. A single property in a single town is concentrated risk. Hold it next to a diversified portfolio, not in place of one.

What we recommend

Underwrite the cash flow first. Net rent against every carrying cost, before appreciation and before tax.
Know your passive loss position before you buy. Above $150,000 of modified AGI, rental losses give you no tax benefit until you sell.
Compare against T-bills as well as stocks. If the property cannot beat the risk-free rate after its costs, the case for it has to be personal use.
Judge the investment on after-tax wealth. The year with the lowest tax bill tells you nothing about the result.

How Summitward helps

Housing runs the rent-versus-buy comparison month by month with your own price, costs, and alternative return, and Tax Projection shows your marginal rate and modified AGI, the two numbers that decide what a rental loss is worth to you and when.

Frequently asked questions

Why do rental losses all show up in the year you sell?

Rental losses are passive. Above $150,000 of modified AGI they cannot offset wages, so they are suspended and carried forward. A fully taxable sale of your entire interest to an unrelated buyer releases all of them in that year as ordinary deductions.

Did the owners come out ahead because of the tax break?

No. In this modeled case the tax break was $44,330, and the owners were still about $148,000 behind their starting point in nominal dollars, before inflation and before any return the money could have earned elsewhere.

Why was there a taxable gain when the price barely changed?

Depreciation reduces your cost basis each year. Sell near your purchase price and the difference between the price and the lowered basis is taxable, at up to 25% for the portion from depreciation.

Why did the next owner make so much more?

Timing. They bought after fifteen flat years, with mortgage rates near record lows, just before a surge in demand for coastal second homes. Over the full twenty years the house moved almost exactly with its regional price index.

Is a vacation home ever a good investment?

It can be if the rent covers its costs, you bought at a reasonable price, and you can hold it through a downturn. Most are better treated as a lifestyle purchase: something you pay for because you use it, priced against the cost of renting the same weeks.

Key takeaways

The lowest-tax year came at the end of a losing investment. For one modeled $300,000 household, releasing fifteen years of suspended losses cut 2020 federal tax from $54,207 to $9,877.
The cash ledger tells the rest. Under the modeled costs, the owners finished about $148,000 behind in nominal dollars after the tax break, and behind Treasury bills by about $187,000.
Entry date drove both owners’ results. The same house returned 0.3% a year from 2005 to 2020 and 12.6% a year from 2020 to 2025, while tracking its regional index over the full period.
Carrying costs set the hurdle. This house needed about 5% a year of appreciation to cover its costs and got 0.3%.
Price a vacation home as something you use. Count the value of the weeks you spend there, and do not count on the investment return.

Related guides

Tax Losses Can Be Valuable. Losing Money Isn’t. covers the general case of losses that come with a deduction.
What a $16,364 Rental Write-Off Is Actually Worth walks through passive loss rules and depreciation on a modeled rental.
Rental Property vs. Global Index Funds compares the two from the purchase decision forward.
Did Buying This House Beat Renting? 24 Years of Real Math runs a primary home through price and avoided rent.
The True Cost of Owning a Home separates cash, economic, and exit value for a house you live in.

Sources

Internal Revenue Service, Publication 527, Residential Rental Property (Including Rental of Vacation Homes): the personal-use test and the 27.5-year recovery period. irs.gov
Internal Revenue Service, Publication 925, Passive Activity and At-Risk Rules: the $25,000 special allowance and its phaseout, and the release of suspended losses on disposition. irs.gov
Internal Revenue Service, Topic No. 409, “Capital Gains and Losses”: unrecaptured section 1250 gain taxed at a maximum 25%. irs.gov
Internal Revenue Service, Revenue Procedure 2019-44: 2020 tax rate tables and the $24,800 standard deduction for joint returns. irs.gov
Bureau of Labor Statistics, CPI-U annual averages: 195.3 for 2005 and 258.8 for 2020. bls.gov
Dividend-adjusted monthly closes for VTI, VT, BND, VGTSX, and VBMFX, Yahoo Finance, June 2005 to September 2020. finance.yahoo.com
Kenneth R. French Data Library, Fama/French research factors (daily), risk-free rate compounded to monthly. dartmouth.edu
Federal Housing Finance Agency, House Price Index, all-transactions, U.S. and census divisions, quarterly (South Atlantic division). fhfa.gov
Freddie Mac, Primary Mortgage Market Survey, weekly 30-year fixed rate history. freddiemac.com
Aswath Damodaran, “Historical Returns on Stocks, Bonds and Bills,” NYU Stern: S&P 500 total returns, 1993–1998. nyu.edu

Editor’s note

Educational content, not tax or investment advice. The sale prices are from public records, rounded, with identifying details removed. The operating costs, the cash purchase, the owners’ income, and the 2020 tax return are modeled; with a mortgage, different costs, or different income the figures change materially. Federal tax only.