Understanding the Taxes When Selling Your Vacation Home
Even if a homeowner has sold a primary residence in their life, that doesn't mean they have a frame of reference for selling a vacation home. The process of selling off a second home will typically be more expensive because the government implements more stringent tax rules for secondary homes, as these are more often strictly investment properties and not primary residences. To find out more about how to sell a vacation home, keep the following facts in mind.
No Breaks for Capital Gains
Capital gains are usually forgiven when selling a primary residence, but not for a vacation home. Those in the upper earnings brackets may have to pay up to 20% of the capital gains of their home (based on purchase vs. sale price.) So if a home was purchased at $475,000 and then sells at $775,000 (after deductions), an owner may need to pay up to $60,000 in taxes. The standard capital gain tax is 15% for those in the middle-income bracket and 0% for those at the lowest end.
New Mortgage Interest Rules
The standard debt limit for deducting mortgage insurance used to be $1 million, but the limits were recently dropped to $750,000. If the owner has two mortgages, this limit will be easy to reach. Anything over $750,000 in total debt, and they homeowners be able to deduct this insurance from their standard taxes. This can heavily impact how much is owed (depending on the total interest between both properties.) Those who may be planning to reinvest their vacation home earnings back into real estate may need to rework their numbers.
How Depreciation Works
Those who rent out the property for some or all of the year should know how their declared depreciation can affect their capital gains. It's normal for owners to declare a significant amount of depreciation of the home simply due to the stress the renters will put on the home. This allows owners to pay lower taxes based on the amount of rental income collected even when the value of the property itself is rising. However, depreciation will lower the original purchase price of the home, thereby increasing the capital gains of the home.
The Case for Deductions
Sellers can deduct plenty of related costs from their vacation home to reduce the amount of capital gains taxes they need to pay. They can deduct major home renovations, closing costs, real estate agent fees, etc. They can even potentially deduct the closing costs from the original purchase of the property. Those who have a property that's steadily risen in value should limit how much depreciation they claim over time and concentrate on deductions so they don't risk higher capital gains.
Owners who want to avoid paying high taxes have a few alternatives. If a vacation home has skyrocketed in value while the value of a primary residence has decreased, families can sell both homes and deduct their capital losses from their capital gains. They can also move into the vacation home while selling the primary. Finally, they can consider a 1031 exchange, where they buy a similar property to the one they owned. This defers taxes as opposed to eliminating them entirely.
Talking to a Malibu real estate or financial professional is typically the best way to avoid paying any additional taxes. Many of these rules can be complicated by the rental schedule, reporting methods, and whether or not the owner buys another property with their earnings.