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Potential Tax Hit for Sellers of Vacation Homes

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Real estate owners get a number of tax breaks from the IRS, both while they own the residence and after they sell it, to a point. In the first of a two-part series, Julian Block discusses how the current rules work for vacation home sellers, as well as times they might take a hit on their income taxes.

Sep 2nd 2021
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Back in 1997, a bi-partisan Senate and House cut a deal with President William Jefferson Clinton. They overwhelmingly passed and he signed legislation that amended Section 121 of the Internal Revenue Code. 

The amendment introduced rules that allow home owners to sidestep taxes. Owners are able to “exclude” (IRS lingo for escape) taxes on sizable portions of profits from sales of main residences. Section 121 doesn’t permit sellers to claim unlimited profit exemptions. It imposes caps that are based on filing status. 

The exclusions top out at $500,000 for: married couples who file joint returns; and qualifying widows/widowers, the IRS term for surviving spouses who qualify for the same breaks as married couple for two years after a spouse’s death. They drop to $250,000 for returns submitted by: single persons; heads of household (mostly unmarried individuals with children); and married couples who file separately. 

When do sellers have to reckon with taxes? Only when their profits surpass the $500,00/$250,000 ceilings.

Key requirements. To illustrate how the current rules work, let’s apply them to sellers Harold and Marian Hill. The couple avail themselves of profit exclusions as long as they comply with two requirements. 

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