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Tax Reminders for Homeowners Who are Thinking of Selling

Apr 11th 2019
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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). 

Replies (4)

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By jykimx95
Apr 14th 2019 17:29

This is a nice summary concerning principal residence and vacation home tax matters. By the way, nearly all CPAs out there don't know anything about the "non-qualified use" that Mr. Block pointed out.

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By skinnyvinny
Apr 18th 2019 17:17

To clarify on the second home gain exclusion, would it be correct that if the home were owned for a total of 20 years, and the owners made it their personal residence for 2 years, then only 10% (2/20) of the gain would be eligible for exclusion?

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Replying to skinnyvinny:
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By jykimx95
Apr 20th 2019 03:33

I think the ownership period before 2009 doesn't count. For example, if the ownership started in 01/01/1999, then the exclusion % would be 60% (12/20) with 10 years before 2009 started and 2 years of personal residence.

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Replying to skinnyvinny:
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By jykimx95
Apr 20th 2019 03:33

I think the ownership period before 2009 doesn't count. For example, if the ownership started in 01/01/1999, then the exclusion % would be 60% (12/20) with 10 years before 2009 started and 2 years of personal residence.

Thanks (0)