Tax Crackdown on Second Homes
To help pay for the housing bill passed this summer, Congress has changed the rules for vacation homes and rental properties. Here's what you need to know about paying the piper.
Congress has pulled the rug out from under vacation-home owners planning to squeeze tax-free profit from their second homes. Under current law, you could sell your primary residence and take up to $250,000 of profit ($500,000 if you file a joint return) tax-free, as long as you owned and lived in the place for two of the five years leading up to the sale.
Row 0 - Cell 0 | Federal Rescue Provisions for Buyers and Sellers |
Row 1 - Cell 0 | New Law Adds Tax Breaks for Real Estate |
Row 2 - Cell 0 | Seniors Get a Gift From the New Housing Law |
Then you could move into your vacation home or a rental property and, by living in it for at least two years, get a second bite of the tax-free apple. Even profit that built up while it was a vacation home or rental could dodge the IRS.
No more. To help pay for the big housing bill passed this summer, Congress has changed the rules so that some of your gain will be taxable if you convert your vacation home or rental unit to a primary residence after 2008.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The portion of the gain to be taxed is based on the ratio of nonqualified use -- the time the property is used as a vacation home or rental unit after this year -- to the total amount of time you owned the property.
Assume you bought a second home in 2000. Let's say you convert it to your primary residence in 2011 and sell it two years later. In this example, the home would be used as a vacation property for two years after 2008, so one-seventh of the profit (two out of the 14 years you owned it) would be taxed at capital-gains rates. The remainder of the gain -- up to $500,000 for couples -- would be tax-free.
This tax-law change could be even more significant if you buy a second home after 2008. In that case, none of the time it is used for vacations or rental income qualifies for the tax exclusion. But if you convert it to your principal residence, the longer you live there, the less the profit from a sale will be taxed. And you can avoid the crackdown altogether if you move in before the end of the year, says Raffaele Mari, a CPA in Corona Del Mar, Cal.
But what do you do with your current home? You could rent it to generate cash flow and buy some time before selling it in this slow housing market, says Mari. The tightening doesn't apply in reverse: You'd still qualify for tax-free profit on the home as long as you sell it within three years to meet the two-of-five-years test.
-
-
Nervous About the Markets and Economy? Consider History
To put things in perspective, focus on what you can control and remember that the ups and downs of the markets and economy can be cyclical.
By Erin Wood, CFP®, CRPC®, FBSⓇ • Published
-
Stung by Netflix Password Sharing Fees? You're Far From Alone
A new streaming survey shows Netflix password sharing changes could affect a surprising percentage of American subscribers.
By Ben Demers • Published
-
Record-High HSA Limit Coming for 2024
The IRS says health savings account contribution amounts are going way up — almost 7% more — for 2024.
By Kelley R. Taylor • Published
-
Etsy, eBay, PayPal Want IRS 1099-K Relief for Online Sellers
Companies like ebay, Etsy, and PayPal want Congress to raise the new $600 reporting threshold for IRS Form1099-K to give relief to millions of sellers who use their sites.
By Kelley R. Taylor • Published
-
Tax Scam: IRS Warns Taxpayers Against Filing False W-2 Info
Scams A new tax scam on social media advises lying on your W-2 to falsely claim credits and bigger refunds.
By Ben Demers • Published
-
529 Plans Get a Boost With Tax-Free Rollovers to Roth IRAs
You’ll soon be able to roll over funds from your 529 plan into a Roth IRA, thanks to recent legislation.
By Erin Bendig • Published
-
Why Your Tax Refund Might Be Lower This Year
According to the IRS, “taxpayers may find their refunds somewhat lower this year," due to the expiration of several major tax breaks that were available to filers during the pandemic.
By Erin Bendig • Published
-
Filing Taxes Early or Later — Which Is Best?
When filing taxes, some people like to file early and others like to file later. Many experts think it's best to file early, but whichever side you're on, here's what you need to know.
By Erin Bendig • Published
-
IRS Says Direct Deposit Is the Best Way to Receive Your Tax Refund
IRS says the best way to receive your tax refund is by direct deposit. Here's how to do it.
By Erin Bendig • Published
-
The 1031 Exchange Rules You Need to Know
Taxes are an inevitable part of investing in real estate. You can, however, defer or avoid paying capital gains taxes by following some simple rules of a 1031 exchange. Yes, you read that correctly!
By Daniel Goodwin • Published