Tax Consequences of Selling a Vacation Home

Just like your primary residence, a second home may have significant appreciation over the last several years. If it’s time to sell, it’s important to understand the tax consequences. 

Let’s look at a couple of examples:

Sale of second home – 100% personal use

Unlike your primary residence, no gain exclusion is available if you sell a vacation home. The gain is fully taxable. Your taxable gain will be the sales price minus selling expenses less your basis in the property. Your basis will be the initial purchase price plus any improvements – decks, docks, new kitchen, etc.

The federal tax rate will be a maximum of 20% if you’ve held over a year. The 20% rate applies for those filing jointly with 2024 adjusted gross income of $584,000 or more. In addition, you may pay net investment income tax (NII) of 3.8% on the gain if your income (married filing jointly) is above $250,000. Then, there is state tax – for Alabama, that’s a flat 5%.

Vacation Home Used as a Rental

The tax consequences are different if the property has been used as a rental, mainly because you’ve likely deducted depreciation as a rental expense. The depreciation you’ve taken will lower your tax basis and subject some of the gain to depreciation recapture (Section 1250 recapture) at a rate of 25%. The remainder of the gain will be taxed as a long-term capital gain, as previously mentioned. On the positive side, you may have prior losses (passive losses) that were suspended, which can be deducted from the year of sale. The sale of a rental property requires a closer look to determine the final tax consequences.

Additional Adjustments to Basis

Don’t forget to adjust the basis if one or both of the property owners have passed away. If a home is purchased and owned by two spouses and one spouse dies one-half of the property gets a step up in basis to fair market value at the time of death.

Planning Opportunities

One option to consider is turning a vacation home into your primary residence, qualifying for the gain exclusion, and selling at a later date. That requires planning, as you cannot generally claim the exclusion unless it’s been two years since you sold another home and used the exclusion. For a refresher on the details, click here: Tax Consequences of Selling Your Home 

As always, it’s better to understand the tax consequences before you sell – give your Dent Moses advisor a call.