As the fall arrives, you may very well be winding down the season at your beloved vacation home. For others, you may find yourself not using a vacation home quite as much as you had dreamed. Unfortunately, the last recession took a toll on the value of vacation homes. The National Association of Realtors reports that, from the end of 2007 through 2012, when primary homes were dropping in value by 14.8%, the value of vacation properties fell by 23%. The good news is that prices have come back strongly. The median price of a vacation home rose 28% in 2015 and another 4.2% in 2016, reaching $200,000.
When it’s time to sell
The $250,000 exclusion from capital gains ($500,000 for married couples filing jointly) for the sale of a principal residence does not apply to the sale of a vacation home. At one time, it was possible to get around this rule by selling one’s principal residence and moving into the vacation home, living in it as the principal residence for at least two years. At that point a new exclusion would become available. This strategy was curtailed, beginning in 2009. Now the exclusion is not available for the portion of your ownership attributable to vacation home use.
Example. You bought a $1 million vacation property in 2010. In 2017, you sold your primary residence to begin living in the vacation home. Now assume that you decide to sell that home in 2020, after living in it for three years, when it is worth $1.5 million. That period is 30% of your total ownership, so only 30% of your gain of $500,000 ($150,000) is excludable from income. The same dollar limit of $250,000 also applies.
The issue of capital gains taxes evaporates if ownership of the vacation home continues until the death of the owner. At that moment, the tax basis of the property steps up to fair market value, so there would be no capital gain on a sale soon after.