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, carsonvalleyland@hotmail.com, www.carsonvalleyland.com

We Are Selling Our Vacation Home … Can We Do A 1031 Tax Deferred Exchange?

Until March of this year vacation homes had a weird non-status … they weren’t investment property and they weren’t personal use property in the eyes of the IRS. To achieve a 1031 Exchange the property must be held for investment or used in a trade or business. After a U.S. Tax Court disallowed a taxpayer’s exchange from one vacation home to another the IRS recognized that some guidelines were needed to establish what could be done to qualify a vacation home for a 1031 Exchange.

The result is a Revenue Procedure ruling that was effective March 10, 2008, the first IRS guidance on the matter since a 1981 letter. The Procedure ruling provides guidelines that the IRS says, if followed, they promise not to challenge the investment nature of your vacation home.

The ruling requires that you hold the relinquished property at least 24 months if it is your vacation home or the acquisition property for 24 months if you intend to buy a vacation home, or for both if you are moving from one vacation home to another. Note that this is more stringent than the one year holding period required for a safe long term capital gain status.

Additionally, for each twelve month block of the holding period you must rent the vacation home at least 14 days at a fair market rent. During that same period, you the owner, can only use the property for the greater of 14 days or 10 percent of the days rented. For instance, if you rented it for 30 days in a year your use is limited to 14 days, but if you rented it for 200 you could use it for 20 days. Days that relatives use the unit for free count against you. Not discussed, but generally understood, is your allowance for maintenance days. You are allowed a reasonable number of “maintenance days” to care for your unit, but don’t try to take a week shampooing the carpets.Our Advice: You now have specific qualifying criteria to meet that will allow you to rest easy knowing that your vacation home exchange will not be challenged. Understand that this is what is known as a “safe harbor”, guidelines that you and your accountant can use with confidence. If you don’t quite qualify it doesn’t mean the end of the world, but you might get looked at closer by the IRS. The best thing you can do is maintain excellent records, be serious in your rental attempts, charge family members market rate for their use, keep detailed records of the dates you use it and what you did, i.e. - maintenance days. Your records are very important for the ultimate success of your exchange.

Tax ramifications are an important component of the buy/sell decision in real estate. The 1031 tax-deferred exchange is designed to encourage the investor to keep his money invested. The ability to defer the tax obligation rather than paying for the taxes on the profit of each transaction along the way can have a significant beneficial impact on your portfolio as you create wealth via real estate. Work with your accountant and real estate agent to maximize your return and minimize your liability as you buy and sell real property.

Experience is Priceless Lisa Wetzel & Jim Valentine; RE/MAX Realty Affiliates, 775-781-5472 or toll free at 800-814-8799 ext. 254, email us at carsonvalleyland@hotmail.com, or visit our website at www.carsonvalleyland.com .