Vacation home tax trap - Part II
There were several follow-up questions to my blog posting last Wednesday on tax law changes that could impact owners of vacation homes. Here are three questions that cover many of the issues raised by readers:
My vacation home has been my primary home since June 2006 . Does the change in the law apply to me? Am I grandfathered in?
Could you please clarify one point in your article regarding vacation homes? You say that changes apply only to vacation homes that you convert to a primary residence. What if it remains as a vacation home and you never make it your primary residence - is it then 100 percent taxable and is this a change from the current law?
This all seems very confusing, where can I get more information about these upcoming changes?
To quickly summarize, the Housing Assistance Act of 2008 contains a provision that will likely negatively impact owners of vacation homes. Before this Act was passed, if you owned a vacation home and you later converted that property to your primary residence, you could exclude 100 percent of the gain, (up to $250,000 for single filers or $500,000 for married filers), on the eventual sale of the home if you owned and used the property as your primary residence for periods totalling at least two years out of the five years ending on the sale date.
Now, the amount of the capital gains exclusion will depend on the percentage of time that the vacation home was actually used as your primary residence.
Here is an example. A couple buys a vacation home, but they are both still working so they do not make it their primary residence. They retire in 15 years and move into what was once their vacation home. They live in the vacation home for 15 more years and then sell the property. If they paid $400,000 for the house originally and sold it for $900,000 30 years later, they would have a gain of $500,000. Under the old law, all of this gain would be exempt from taxes. However, under the new law, only 50 percent of the gain would be exempt from taxation because the couple only used the home as a primary residence for half of the total time they owned it. The end result will be a pretty big tax hit.
So, to answer the new questions:
This new law does not take effect until January 1, 2009. Assuming there are no changes to the Act and the January 1st effective date, anyone who has already made their "old" vacation home their primary residence, should not be affected by this change. However, you should consult with an advisor or accountant to confirm the specifics of your personal situation.
Also, if you never plan to convert the vacation property to your primary residence, there will be no changes. The cap gains exclusion is only available to individuals selling their primary residence. Gains on the sale of vacation homes that were never used as a primary residence will be taxable as they always have been.
For more information, google "Housing Assistance Act of 2008" or read this CCH report.
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