When it comes to selling a vacation home, owners need to consider how the government will process the sale before they start taking offers. Some sellers will choose alternate paths based on everything from their individual capital gain rate to the overall depreciation rate of the home. And though the mortgage requirements for buying a vacation home are different, the tax implications of selling are as well. Learn which factors will have the biggest impact on the profit margins of the sale and how to maximize those margins without breaking the law.
Capital Gains and Vacation Homes
Capital gains refer to profits made from buying something (e.g., a stock, home, Elvis lunchbox, etc.) at one price and then selling it for an appreciated value. The government will tax the profits made on the property based on the annual income of the seller. The average rate of capital gains is 15%, but can rise as high as 20%. (Those making under a certain income a year will not be subject to capital gains tax.)
So, let’s say an owner makes $60,000 a year and purchased their vacation home for $100,000 (net) in 1985. If they sell that home in 2019 for $300,000 (net), then they’ll owe $30,000 to the government based on a 15% capital gains tax.
Expenses and Capital Gains
The key to capital gain calculations is how much profit a person made off the purchase. Vacation homeowners are allowed to deduct related expenses to shrink the gap of appreciation (and thus their overall taxes).
Eligible expenditures include, but are not limited to, the following:
- Closing costs
- Major renovations
- Marketing expenses
- Capital losses
If the seller redid the kitchen last year, they’re allowed to deduct the total cost of the renovation along with the real estate agent commission, the drone shots, and the inspection fees. If the seller has suffered capital losses via the stock market or their primary home, they’re allowed to adjust their capital gains profits based on those losses.
How Depreciation Works
If the vacation home was primarily being used as a rental, there’s no doubt that the homeowner claimed depreciation to take some pressure off their income taxes. However, depreciation is a double-edged sword in that it’s the depreciated value (and not the original sale value) that will be used to calculate the capital gains. If a seller claims that their property depreciated by $50,000 over the course of ownership, they’re expected to pay capital gains on that depreciated value if the home sells for a profit.
How to Mitigate Taxes
Those who want to avoid or reduce capital gains tax can consider the following options:
- Selling a primary home: If a primary home has depreciated for around the same amount that the second home has appreciated, sellers can potentially use the capital losses to cancel out the capital gains.
- Moving into the second home: Capital gains for primary homes are essentially non-existent. Some owners will play the long game on a lucrative vacation home by selling their primary home and moving into the vacation for two years to establish residency.
- 1031 exchange: This complicated option involves selling the vacation home and buying a new property of the same price. This option will only defer capital gains but can be useful for serial investors.
- Legacy: Sellers can give their vacation home to their children instead of paying capital gains. However, children will have to balance the value of the home based on a new assessment at the time of move-in.
Sellers of vacation homes in Tomball have a lot of potential deductions to consider, which is why talking to a financial expert can be the key to getting this right. For homes that have increased significantly in value, it’s all too easy to overpay in taxes. Going over the options with a professional can help sellers find the answer.