Vacation Homes, Rental Homes, Primary Residences and the Capital Gains Exclusion | USTaxAid

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Vacation Homes, Rental Homes, Primary Residences and the Capital Gains Exclusion

Written by Diane Kennedy, CPA on May 8, 2022

First, let’s assume you are selling a primary residence. The value has gone up, so you’re going to have gain when you sell. The most common phrase used when selling a primary residence for a whole lot less tax is “2 out of 5 years.” This means if you lived in your home for 2 of the previous 5 years you can take a capital gains exclusion of $250,000 for single and $500,000 for married, filing jointly.

It’s not quite that simple. If, for example, you rented it out first and then later moved into it, you will need to pro-rate the exclusion. If you lived in it first and then rented it out, you don’t need to pro-rate.

And you’d don’t necessarily need to live in it for the full 2 years if you qualify for “unforeseen circumstances.”

More information here:

The Two Out of Five Rule Doesn’t Work In This Case

IRS Says Not So Fast on Two Out of Five Primary Residence Rule

Little Known Tax Strategy If You Sell Your Home Before the Two Year Window

And then it even gets more complicated. What if it’s a vacation home?  The answer may surprise you. 

The Vacation Home-Rental Home Dilemma

The difference between a rental home and a vacation home has to do with days. If you own a home and rent it out for less than 15 days in a year, you don’t need to report the income. 

If you rent out a home for more than 15 days, it is a vacation/second home if your personal use is more than the greater of:

  1. 14 days, or
  2. 10% of the total number of days you rent it out to others. 

For the time that you’re holding it, you’re at a tax disadvantage. You won’t be able to deduct any loss you receive.

But when you sell it, you may have a slight advantage with a vacation home.

If you rent your house out first, then move into it, you will need to pro-rate the gain exclusion. For example, let’s say you rent it for 5 years and then live in it for 5 years. You only qualify to get half the capital gain exclusion (5/10).

However, it’s been a vacation home and you move into it, you do not need to pro-rate it. Live in it for 2 years as your primary residence and then sell it to get the full capital gain exclusion.

Capital Gain Exclusion Strategies

Nothing in tax law is simple these days. There are loopholes everywhere when it comes to the capital gain exclusion.

If you have unforeseen circumstances that qualify, you don’t need to live in the home for a full 2 years.

If you move out and rent the house out on a temporary basis, the time away doesn’t count.

If you use a vacation rental part of the time, take on a full time roommate or run your business out of part of the house, you will get the full capital gain exclusion.

When it comes to taxes, the more you know, the more you save.  Join us for the 1st – 4th Wednesday Coaching. If you can’t make a live session, you can always pick it up later on the recording posted on the coaching page. 

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