In general, owners can get way more than they paid for their vacation home if it’s located in an upscale area. While this is a good thing for the home owner, what about taxes? Continue reading for three scenarios to demonstrate the federal income tax repercussions you may face for taxes on an appreciated vacation home.
Taxes On An Appreciated Vacation Home
The California median home price forecast is for a rise of 6.2% to $860,300 this year. And the federal income tax home sale gain exclusion break is still on the books. Although this all sounds fantastic, it’s only available for the sale of a principle residence. With this in mind, sometimes a vacation home will qualify for the gain exclusion break. For instance, if you also used the property as a principal residence.
Below are 3 chain of events that show how you may be faced with federal income tax issues when selling an appreciated vacation home.
1. For a time, you used the vacation home as a principal residence
In this situation, you might be able to claim the tax-saving principal residence gain exclusion break. You probably qualify for the exclusion if you owned and used the property as your principal residence for at least two years during the five-year period ending on the sale date.
There’s another major qualification rule for the home sale gain exclusion tax break. The exclusion is generally available only when you’ve not excluded an earlier gain within the two-year period ending on the date of the later sale. In short, you generally cannot claim the gain exclusion until two years have past since you last used it.
Also, if you have a really big gain from selling your vacation home, it may be too big to fully shelter with the gain exclusion. Even if you qualify for the maximum $250,000/$500,000 break. Assuming you’ve owned the property for more than one year, the part of the gain that can’t be excluded will be an LTCG tax.
2. You have never use the home as a principal residence
In this case, the home sale gain exclusion tax break (up to $250,000 or $500,000 for a married couple) is unavailable. In fact, your vacation home sale profit will be treated as a capital gain.
If you’ve owned the property for more than one year, the gain will be taxed at no more than the 20% maximum federal rate on long-term capital gains (LTCGs). Plus, the net investment income tax (NIIT), if applicable. However, the 20% rate only applies to the lesser of:
- The excess of your taxable income, including any net LTCG, over the applicable threshold, OR
- Your net LTCG for the year
For 2024, the thresholds are $551,350 for heads of households, $518,900 for single filers and $583,750 for married joint filers. The maximum federal rate on net LTCGs is 15% if your taxable income is below the applicable threshold.
But if you also owe the 3.8% NIIT, the effective federal rate on some or all of your net LTCG will be 18.8% (15% + 3.8%) or 23.8% (20% + 3.8%). And you may also owe state income tax!
3. You rented out the vacation home
For this situation, you most likely deducted depreciation for rental periods. If you did, the federal rate on gain attributable to depreciation can be up to 25%. Of course, this is assuming you held the property for over one year. You might also owe the 3.8% NIIT on the gain attributable to depreciation. And any remaining gain will be taxed at the federal rates explained earlier.
Did you rent out the vacation home but used it only a little for personal purposes? Assuming the answer is yes, then it might have been classified as a rental property for federal tax purposes. If this is the case, you might have had rental losses that couldn’t be deducted currently due to passive activity loss (PAL) rules. Luckily, you can deduct these suspended PALs when the property is sold.
Conclusion
As you can see from the above, managing an estate or property of any kind can be complicated, especially with all of the IRS’s acronyms 😉. And being certain about which taxes apply to the sell of an appreciated vacation home is definitely worth consulting with a professional tax consultant. The thing is, we haven’t even covered all of the potential issues here.
The tax professionals at The Ray Group will fill in the blanks on your specific situation and answer questions that you may have. Contact us today for tax help with your appreciated vacation home or other tax situations.
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