Downsizing has been on the minds of millions of Americans over the past few years, including investors selling a vacation home. Homeowners are also no different, particularly in Utah, where ownership of multiple homes isn’t just a sign of success. It’s a commonplace occurrence.
But there’s a downside to selling a vacation home in Utah, whether it’s a rental property or a 2nd home. It’s called the capital gains tax and it’s something that makes many homeowners think twice about selling a second home.
Briefly put, capital gains tax occurs after the sale of any asset, including timeshares and both real and personal property. And capital gains tax on second homes has been a long running thorn in the side of many homeowners. Depending on both your household income and the size of the investment itself, it can range from 0 (for households making less than $39,375 per year) all the way up to 20 percent (for households making more than $434,551 per year.) Assuming you fall into the latter category, that $240,000 vacation home in Ogden you were hoping to sell at market value? You’re going to wind up paying a capital gains tax to the tune of $48,000.
But there are some things to keep in mind about selling a vacation home that can help minimize your capital gains tax liability.
When Is It A Vacation Home And When Is It A Rental?
The obvious answer is simple: when you stand to make a personal profit from it.
Except it’s not always that simple to the IRS. For one, selling a vacation home is taxed as a personal capital asset, which means it’s subject to the same tax rate as the sale of a second home. However, capital gains tax on a second home is predicated on the difference between the basis of its cost and profit from its net selling price.
The former doesn’t include home renovations, or acquisition and origination fees; all of which can and will ultimately affect any profit you might make from its net sale. Which means any amount you may have paid in improvement and acquisition costs may ultimately be non-taxable. Please consult a trusted tax adviser if you have specific questions about the tax liability of your vacation home.
Rental properties, on the other hand, are viewed as a capital tax gain or loss based on three specific factors:
- Your initial investment.
- The cost of any improvements or renovations you made.
- Any depreciation deductions you’re claiming.
It’s the latter which tends to be confusing when justifying a home as a capital loss. It’s common for rental owners to claim depreciation as a result of age and general usage on property in order to reduce taxable income. But it may result in what’s known as depreciation recapture, which is taxed at a flat rate of 25 percent upon its sale—with one particular exception.
If the final value of your home has actually depreciated and your improvements have exceeded the deductions you’re claiming, it may be claimable as a Section 1231 tax loss. However, this can be a complicated circumstance to navigate and is completely dependent on a number of personal factors. Again, we recommend consulting a tax professional before claiming property as a 1231 tax loss.
Strategies For Selling A Vacation Home In Utah
1. Defer Taxes Through A 1031 Property Exchange
A Section 1031 (or like-kind) exchange occurs as the result of exchanging the proceeds from the sale of one property into another of greater or equal value. So long as the property you’re exchanging it for isn’t of lesser value, there’s no actual limit to how many times a 1031 exchange can be conducted. But you would need to identify a replacement property within 45 days of the sale of your vacation home, and no more than 180 days to actually close on the property.
2. Balance Capital Gains With Losses
Any losses you may have incurred as a result of other investments such as stocks, bonds and mutual funds can be used to help offset the capital gains tax from the sale of your vacation home. If the actual amount exceeds your tax, you may want to look into reporting them when you file.
3. Transform Your Vacation Home Into Your Primary Residence
IRS law states that if you’ve lived in a home for two years out of the past five prior to a sale, it’s considered your primary residence. Capital gains tax cannot be applied to a primary residence but only a secondary. And if you find that your own residence has depreciated considerably in value while your vacation home remains stable, this may be an ideal solution to minimize any capital gain from a sale—so long as the arrangement is convenient for both your lifestyle and work.
There’s just one potential problem with this solution: what to do with your primary home after you move. If it has depreciated in value by IRS standards, then it’s depreciated significantly by Utah real estate standards. While trends in the market may come and go, the need to sell your house won’t. And if you’ve listed a property for over six months and haven’t found a buyer, chances are you’re not going to find one any time soon unless you’re willing to take a loss.
But just how much of a loss are you willing to take? The likelihood of finding the right buyer at the right time at a price that’s right for you isn’t always guaranteed. Remember, they’ll be working with agents whose job is to find them the best deal imaginable. And you may find yourself negotiating for considerably less than what you expected.
That’s why we can help. At Gary Buys Houses, we’ve helped hundreds of Utah residents solve capital gains dilemmas by purchasing both primary and vacation homes as is at a price that’s fair, convenient and fast—sometimes in as little as 3 – 5 business days.
Taxes may be inconvenient. But that doesn’t mean selling your vacation home has to be so long as you choose the strategy that’s right for you.