A Vacation Home Can Take a Capital Gains Exclusion If You Use This Strategy First | USTaxAid

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A Vacation Home Can Take a Capital Gains Exclusion If You Use This Strategy First

Written by Diane Kennedy, CPA on April 2, 2022

Real estate values are way up in many areas and you may be looking at selling to cash in on the equity. But with gains, there are often taxes. How can you pay less tax when you sell your real estate at a profit?

One of the best tax gifts that Congress ever gave us was the capital gains exclusion when you sell your house. Years ago, (MANY years ago) you had to reinvest in another home when you sold in order to get the exclusion. Or you got an exclusion if you were over 55 years of age. That changed back in 1997 when Section 121 was expanded to the current 2 out of 5 rule. If you live in your previous home for 2 of the previous 5 years, you can exclude up to $250,000 of gain if you’re single and up to $500K of gain if you’re married filing jointly. 

In 2009, this was modified to a requirement to apportion the capital gain exclusion if the property started out life as a rental. You could live in it first and then rent it out. That’s okay. But if you rent it first and then move in to it, then you will have a limit on the capital gain exclusion.

You can read more information about this at:

2 out of 5 Rule Changes January 2009

Exceptions to the 2 out of 5 Primary Residence Rule

Vacation Home and Primary Home Both – Now What? 

What if you have both a primary home and a vacation home? That leads up to a question that I received at US TaxAid. It has been paraphrased below. 

“I owned 2 homes. One was a vacation home and never rented out. I sold my primary residence in May and moved into the vacation home. Then I sold it in October, closing in December. Does the first home qualify for capital gain exclusion? What about the vacation home?”

If you lived in the primary residence for at least 2 years (assuming the 2 out of 5 rule), you can take the capital gain exclusion. This assumes you never rented it out. The capital gain exclusion will be up to $250K for single and $500K married filing jointly. 

The vacation home is a different story. You didn’t mention years here, but if you just lived in the vacation home as your primary residence for a few months (May to October), then you clearly haven’t lived there for 2 years.

If the October referenced above is several years later, then you may qualify for the 2 out of 5 years. Since it was never rented, you don’t need to prorate the capital gains exclusion. However you need to have lived in the home long enough. 

Do you HAVE to Live In Your Home for 2 Years to Get the Exclusion?

If you haven’t lived in your home for the full 2 years there could still be a way to get some of the capital gain exclusion. That’s with the “unforeseen circumstances” piece of tax law. The IRS spells out what qualifies as unforeseen circumstances : 

  1. The owner has  died,
  2. Became divorced or legally separated, 
  3. Gave birth to 2 or more children from the same pregnancy, 
  4. Became eligible for unemployment compensation, 
  5. Had a change in employment status and as a result need to change cost of living expenses, and
  6. Other unforeseen events that necessitate a move by the taxpayer.

The last one is pretty subjective, though. Take a look at Little Known Tax Strategy if You Sell Your Home Before the Two Year Window to find out if you can qualify for this exclusion.

The capital gain exclusion for your primary home is more complicated than you may realize! If the home had instead been rented instead of being exclusively a vacation home, the capital gain exclusion may not apply at all. Or if the owner or owner’s spouse had recently sold another property and took the capital gain exclusion on that as a primary residence, the capital gain exclusion may not be available after all for this sale.

Got a complicated capital gains exclusion question? The best time to get the answer is BEFORE you sell the property. The most cost effective way to get personalized answers to these and other tax questions is to join our Wednesday Coaching.

We meet on the 1st – 4th Wednesday at 5 pm Pacific. Each week we cover a specific Home Study Course and, of course, answer your questions.

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