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GOT A VACATION home? There’s an overlooked tax break if you rent it out—but a potential tax hit if you sell.
First, the tax break: Long-standing rules allow homeowners to completely sidestep taxes on rental income—provided they meet a key requirement: They rent out their cottage or condo for less than 15 days during the year.
That can be a great tax break for those who own dwellings near annual events where rents soar for short periods. Some examples: Indianapolis for the Memorial Day car race, Louisville during Derby week and Augusta during its Masters tournament.
Next, the potential tax hit: The law allows individuals who sell their main residence to escape taxes on a profit of as much as $500,000 for married persons filing jointly, and up to $250,000 for single persons and married persons filing separate returns. To qualify for the exclusion, you must own and use the dwelling as a principal residence for at least two years out of the five-year period that ends on the sale date.
But what if you’re selling a second home? At one time, a seller could occupy a vacation dwelling for two years and then claim the $500,000 exclusion. But current law limits the amount of the exclusion when a second home becomes your principal residence.
The revised rules prohibit any exclusion for profit attributable to what the IRS characterizes as post-2008 periods of “nonqualified use.” Put more plainly, the IRS means those periods during which the former second home wasn’t used as your principal residence.
Not all of my clients reap gains when they sell their homes. Some suffer losses. While the housing market is buoyant in many parts of the country, it remains depressed in some places. Many people face the prospect of losing money when they try to unload either a principal residence or a vacation home.
The tax code has always prohibited write-offs for such losses—and, no, there are no extenuating circumstances. For instance, an IRS ruling barred a deduction for a home-sale loss when a family, with a child in a wheelchair, made a doctor-recommended move from a two-story to a one-story house.
Julian Block wrote and practiced law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). He died in 2023. Check out the articles that Julian wrote for HumbleDollar.
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Thanks, didn’t know about those revised rules. Somewhat related, on other revisions that may not matter — I think that while mortgage interest and property tax deduction are now limited, they don’t apply to investment property, as these aren’t taken aren’t taken as annual deductions from income, but rather they offset the gains realized when the home is sold. Is that correct?
There does seem to be a misunderstanding on your part. Form 1040’s Schedule is for reporting income and losses from, say, rental property. Mortgage interest and property taxes are claimed. As for a vacation home that’s not rented out, property taxes are subject to the new limit of $10,000. Hope that helps.
Mortgage interest, property taxes, depreciation and other expenses are deducted from investment property each year. When you sell investment property you have at least two options 1) pay taxes on the capital gain and the recaptured depreciation (taxed at your marginal rate) and 2) defer taxes by purchasing a new property through a 1031 exchange.