A Second Home & Capital Gain Tax Rules
The Internal Revenue Code treats all property you purchase for personal use, including second homes, as a capital asset. Transactions that involve the sale of a capital asset are subject to capital gains taxes. Capital gain rates are preferable for most taxpayers as they impose tax rates lower than the ordinary income tax rates that employment and business earnings are subjected to. However, capital losses provide less benefit than ordinary income deductions.
Tax Basis
When you purchase a second home, you must keep track of its tax basis. A home's tax basis includes the purchase price and settlement costs you incur at closing. The home's tax basis increases for the costs that relate to permanent home improvements. To increase basis, the improvement must either add value to the home or prolong its useful life. However, costs you incur for home repairs such as painting and landscaping do not increase tax basis. Additionally, it is irrelevant how you obtain the funds to purchase or improve the home for purposes of calculating tax basis. (See Reference 1.)
Calculating Taxable Gain
An accurate tax basis is imperative when calculating the gain on the sale of a second home. The tax basis represents the total cost or investment you have in the home. Any sale proceeds in excess of the tax basis are subject to taxation at capital gain rates. In addition to the sales price of the home, sale proceeds include any liability on the home a buyer assumes plus any other property you receive in the transaction. (See Reference 2.)
Reporting Gain
Individual taxpayers must report the details of the transaction on the Schedule D attachment to a personal income tax return. You must pay any resulting tax liability from the transaction by the tax return's due date. However, you may reduce the amount of gain subject to tax with any capital loss carryovers remaining from prior years and capital losses you incur in the current year. For this purpose, it is important that you retain adequate records of all unused capital losses. (See Reference 3.)
Gain Exclusion
The IRS allows you to exclude up to $250,000 of capital gain from taxation that result from the sale of a main home. To qualify, you must own the home for at least two years, and use it as the principal residence for two years during the five-year period that precedes the date of sale. Additionally, you must not have excluded home gain in either of the two years that immediately precede the date of sale. Although homes you designate as a second home may not meet the requirements of being the main home, you have the opportunity to designate the second home as the main home if you meet the requirements. For example, if you split your time equally between two homes or spend two-fifths of your time at the second home in the previous five years, you can qualify for the exclusion. The requirement that you live in the home for two years need not be consecutive. (See Reference 3.)
Tags: capital losses, home basis, main home, second home, capital asset
