The tax-code-defined vacation home rules come into play when you have both rental and personal use of a home. Thus, you can have tax-code-defined vacation homes in the city, in the suburbs, and in recreation areas.
The rules are easy if you have no combined rental and personal use of the home. The property is one of the following:
- Principal residence
- Second home
- Rental property
But when you have both rental and personal use of the home, your tax life gets more complicated because you have entered the tax code’s vacation home section. In this situation, the property in a more complicated way is one of the following:
- Principal residence
- Second home
- Rental property
The $250,000/$500,000 home sale exclusion is available when you sell if it’s a principal residence.
If it’s simply a second home, you can’t use the exclusion and pay taxes at capital gains rates—and you may also suffer the net investment income tax (NIIT).
If it’s a rental, you face the capital gains rules, NIIT, unrecaptured Section 1250 gain taxes, and release of some (if grouped) or all (if not grouped) passive activity suspended losses.
When you have rental use after 2008 and convert the rental to your principal residence, you must use a rental/residence fraction to determine how you will be taxed.
If you’re thinking of purchasing a vacation home or have tax-related questions about your current appreciated vacation home or rental, it’s best to speak with your wealth advisor or other trusted financial professional to ensure you understand the tax implications.
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