Owning an appreciated vacation home is typically beneficial. You’re likely to make a profit when you sell it, compared to the original purchase price. However, there are other considerations to keep in mind when selling your home, particularly taxes. The federal income taxes owed from the sale can be complex, but we hope these three scenarios will help guide you.
Scenario 1: Your Vacation Home is Your Principal Residence
If you’ve owned and used the home as your primary residence for at least two of the five years before selling, then you can qualify for the tax-saving principal residence gain exclusion break. This tax break allows homeowners to exclude a significant portion of the capital gain from the sale of their primary residence from federal income taxes (up to $250,000 of capital gains if you're single, or up to $500,000 if you're married and filing jointly.)
On the other hand, if you realize a significant gain from selling your vacation home, the gain may exceed the amount you can exclude under the principal residence gain exclusion — even if you qualify for the maximum $250,000/$500,000 exclusion. Assuming you’ve owned the property for more than one year, the portion of the gain that cannot be excluded will be considered a long-term capital gain (LTCG) and taxed according to the applicable rules.
Scenario 2: You Rent Out your Vacation Home
In this scenario, your property is classified as a rental property for federal tax purposes. So, you might have incurred rental losses that couldn’t be deducted immediately because of the passive activity loss (PAL) rules. However, once sold, these suspended PALs can be deducted.
You likely deducted depreciation for rental periods. If so, the gain attributable to depreciation (known as unrecaptured Section 1250 gain) can be taxed at a federal rate of up to 25%, if you’ve held the property for more than one year. Additionally, you may owe the 3.8% Net Investment Income Tax (NIIT) on the unrecaptured Section 1250 gain. Any remaining gain will be taxed at the federal rates mentioned below.
Scenario 3: You’ve Never Used your Vacation Home as your Principal Residence
In this scenario, your home sale gain exclusion tax break (up to $250,000 or $500,000 for a married couple) is unavailable. The sale profit will be treated as a capital gain.
If you've owned the property for over a year, any gain will be subject to a maximum federal tax rate of 20% on long-term capital gains (LTCGs), plus the net investment income tax (NIIT) if applicable. However, the 20% rate applies to the lesser of:
Your net LTCG for the year, or
The excess of your taxable income, including any net LTCG, over the applicable threshold.
For 2024, the thresholds are $518,900 for single filers, $583,750 for married joint filers and $551,350 for heads of households. If your taxable income is below the applicable threshold, the maximum federal rate on net LTCGs is 15%. You may owe state income tax, as well.
In summary, taxes on selling a vacation home vary based on how you've used the property. If you've never used it as your primary residence or rented it out, calculating taxes is simpler. However, if your vacation home had multiple uses, the tax process can be more complicated. When you're ready to sell or have already sold your home, consult with us. Our CPAs are here to answer your questions and assist you through the process.