Tax Treatment for the Sale of a Vacation Home

The sale of a vacation home, defined as a second property not used as your main home, carries different tax implications than selling a primary residence. The tax treatment for any gains or losses depends on how you used the property, how long you owned it, and your overall income.

Calculating the Gain or Loss on the Sale

To calculate your financial gain or loss, begin with the property’s selling price. From this amount, subtract any selling expenses, such as real estate commissions, advertising fees, and legal fees, to determine the amount realized from the sale.

Next, you must determine the property’s adjusted basis. Your initial basis is what you paid for the home, including certain settlement fees and closing costs. This basis is increased by the cost of capital improvements that add value or prolong its life, such as a new roof or a kitchen remodel.

Simple repairs and maintenance do not increase your basis. The basis is reduced by any depreciation you claimed if the property was rented out or by casualty loss deductions you took. Subtracting the final adjusted basis from the amount realized reveals your total gain or loss.

Determining the Taxable Portion of the Gain

The taxability of your gain depends on how long you owned the vacation home. If you owned the property for one year or less, the profit is a short-term capital gain taxed at your ordinary income tax rates. If you owned it for more than one year, it qualifies as a long-term capital gain, which has lower tax rates of 0%, 15%, or 20%, depending on your taxable income.

If the vacation home was ever used as a rental, the calculation is more complex. Any gain from depreciation deductions you claimed is subject to depreciation recapture and is taxed at a maximum rate of 25%. The remaining profit is then treated as a long-term capital gain if you owned the property for more than one year.

The tax treatment for losses is also distinct. If you sell a vacation home used exclusively for personal purposes at a loss, it is a non-deductible personal loss. However, if the property was held for investment or used as a rental, a loss on the sale may be deductible, subject to certain limitations.

Applying the Principal Residence Exclusion

The home sale exclusion, which allows a taxpayer to exclude up to $250,000 of gain ($500,000 for married couples filing jointly), can sometimes be used for a vacation home. To qualify, you must have owned and used the property as your main home for at least two of the five years before the sale. This means you can convert a vacation home into a primary residence to use this exclusion.

To do so, you must move into the vacation home and make it your main home for at least two years before selling it. This allows you to meet the ownership and use tests required for the exclusion.

A limitation applies if the property was used for purposes other than as a primary residence. Any gain related to periods of “nonqualified use” after December 31, 2008, is not eligible for the exclusion. Nonqualified use includes time the property was a vacation home or a rental, and the ineligible portion of the gain is based on a ratio of nonqualified use to your total ownership period.

Reporting the Sale to the IRS

You must report the sale to the IRS on your annual tax return using Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. On Form 8949, you will report the details of the sale, including acquisition and sale dates, the sales price, and your adjusted basis. Information from Form 1099-S, Proceeds From Real Estate Transactions, can help you complete this.

The totals from Form 8949 are then transferred to Schedule D, which summarizes all your capital gain and loss activity for the year. The final figure from Schedule D is carried over to your main tax form, Form 1040. This amount is included in your overall taxable income.