Introduction
Selling a vacation home brings with it several important tax considerations that differ from those applied to the sale of a primary residence. Understanding how the IRS classifies your property—whether as a vacation home, rental property, or second home—is critical to determining the correct tax treatment. From capital gains implications to how losses and closing costs are handled, the rules surrounding the sale of a vacation property can impact your net proceeds and tax liability. Proper classification and preparation can help you navigate these rules more effectively and avoid unexpected tax consequences.
What are some tax considerations associated with selling a vacation home?
If you sell your vacation home and wish to know the tax consequences, you must first determine whether your residence qualifies as a vacation home in the eyes of the IRS. Assuming that it does, you should know how to treat capital gains and losses. You should also know what to do about closing costs.
What is the tax definition of a vacation home?
The tax treatment of your additional residence depends on how often the residence is used for personal purposes relative to the amount of time it is used for rental purposes. From a tax perspective, rental properties with personal use by the owner generally fall into one of four categories:
- Personal residence–Typically, this is a residence that is not rented at all or is rented for fewer than 15 days during the year. If it is your primary place of abode, then it is your principal residence.
- Vacation home–This is a second residence with a combination of personal and rental use. The home is rented 15 days or more per year, and personal use exceeds the greater of 14 days per year or 10 percent of the days rented. Vacation home tax rules will apply.
- Second home–If you have a second home/vacation home that is rented less than 15 days per year, and your personal use exceeds the greater of 14 days per year or 10 percent of the days rented, the second home tax rules apply.
- Rental property (with or without personal use)–This is property used personally for fewer than 15 days per year (or, if greater, for 10 percent or less of the rental days).
Capital gains and vacation homes
A capital gain occurs when you sell a capital asset for more than your adjusted basis in the property. Generally speaking, the adjusted basis of a personal residence is the cost of the property (i.e., what you paid for the property when you first purchased it), plus amounts paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes. Improvements add value to a home, prolong its life, or adapt it to a new use. Regular repairs and maintenance are not considered improvements.
Regarding the sale of a vacation home, any gain must be calculated as if you had owned two properties–one for personal use and one for rental use. Gain attributable to the personal use portion is reportable as capital gain.
The gain attributable to the rental portion of the vacation home is considered part ordinary income and part capital gain.
Is there an exclusion from capital gain?
No. Unlike the case of a principal residence, you aren’t allowed a capital gain exclusion when you sell a vacation home, second home, or rental home.
Losses and vacation homes
If you sell a vacation home at a loss, no capital loss is allowed on the personal use portion. You are allowed an ordinary loss on the rental portion of the home, however, as long as the rental wasn’t considered a temporary one.
It is important to note that you cannot deduct a loss on the sale of a timeshare. Furthermore, you cannot deduct a loss on the sale of a second home.
Closing costs
Generally, you cannot deduct settlement costs on your tax return when you sell your home. Often, however, you can reduce the amount realized from the sale. This can be advantageous for capital gain tax purposes. If you pay certain settlement costs, such as a broker’s commission, points owed by the buyer, transfer taxes, and other costs owed by the buyer, you can reduce the “amount realized” (i.e., the sales price).
Conclusion
Whether your vacation home was used strictly for personal enjoyment, partially rented, or primarily used as an income-producing property, the way it was used will determine your tax obligations upon sale. While capital gains exclusions typically do not apply, some tax-saving opportunities may still exist depending on your use history and financial records. Accurate tracking of improvements, rental use, and closing costs can help reduce your taxable gain or support a loss claim on the rental portion. Due to the complexity of these rules, consulting a tax professional is strongly recommended before completing the sale.
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Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
