Thursday, October 16, 2008

Can We Convert Our Vacation Home To A Primary Residence For Taxes?

Yes, you can, but be advised that the rules are changing on January 1, 2009. Though the Housing Assistance Act of 2008 was primarily designed to provide relief for homeowner’s facing foreclosure, a provision was included to help the government generate more taxes that will have an effect on you when you sell your second homes after that date.

Under the old rules you could sell your primary residence and your vacation home and keep up to $500,000 (married) in profit from both if you owned and lived in each appropriately. The new rule allows profit exclusion only up to the actual percentage of the time of total ownership that it was used as a primary residence. For example, you buy a home next year and use it as a vacation home for ten years. Then you sell your primary residence and move to the vacation home full time. After fifteen years you sell it. You will have owned the property for 25 years, 10 as a vacation home and 15 as your primary residence. Your primary residence period, 15 years, is 60% of the total ownership period. Under the new law, if you made $250,000 profit you can exclude $150,000 from taxation and will have to pay capital gains on the remainder profit of $100,000.

The new rule does not include ownership time prior to the enactment date, January 1, 2009. Using the above example, if you owned it for 5 years prior to that date, held it for the same 25 years, and moved in for the same 15 years, and were fortunate enough to realize the same $250,000 profit, you can now exclude $200,000 of profit, a tax savings of $37,500.

Loophole: Primary residences are granted a special tax status regardless of their subsequent use. This creates a potential loophole, i.e.- on January 1, 2009 you move out of your primary residence and into your vacation home. On January 2, 2011 you sell your then-primary residence and take the maximum exclusion on the profit. You then move back to the original primary residence and take the exclusion as long as you meet the basic criteria, i.e.- live in it two of the last five years, etc.

Our advice: Many people adjust their holding plans/strategy according to the tax consequence of their actions, and this new tax provision will undoubtedly result in owners holding their property longer. If held until their demise their heirs would have a stepped up basis in the property and little tax consequence to a subsequent sale. Beware of adjusting your holding plans too much, however, since this tax change will likely have an effect on vacation home markets and your property’s market value may change over time nullifying any tax savings you are protecting by holding. If your second property was a rental unit before you moved into it, remember that you may have to recapture depreciation.

Planning your real estate moves based on taxes should be done in concert with the advice of your tax advisor. Real estate agents have working knowledge of real estate related taxes, but don’t know your entire portfolio or financial circumstance, or enough about the tax code, to provide tax advice. Consult your accountant to assess the tax consequences of a sale or transfer.
Experience is Priceless! Lisa Wetzel & Jim Valentine, RE/MAX Realty Affiliates, 775-781-5472,,

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