Got a vacation home? There’s an overlooked tax break if you rent it out—but a potential 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 the 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 agency 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.
Nor does the IRS care that a homeowner is out of pocket because a job relocation triggered by a layoff, illness, death, divorce or the like compelled a sudden sale before a residence appreciated sufficiently to offset brokerage commissions, legal fees and other expenses involved in buying and selling.
Consistent with that approach, a loss isn’t deductible when an employee moves to take a new job or is transferred to a new location. Well, what if her employer reimburses her for the loss? No offset of an otherwise nondeductible loss against the reimbursement, because they’re separate transactions. The loss stays nondeductible.
In the event of a profit, is she allowed to include the reimbursement as part of the selling price and avail herself of an exclusion of as much as $500,000? Nope, it counts as income, says the IRS.
Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 250 and counting).
About Julian Block
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com.