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An End to the Beach House Loophole?
After Jan. 1, a new tax law is expected to apply to capital gains on the sale of a home, with particular consequences for vacation homes claimed as principal residences. Sellers may only qualify for a fraction of the current exemption.
(By Robert A. Reeder -- The Washington Post)
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Say, for example, you bought a mountain cabin 10 years ago and have used it only for vacations. Next spring, you make it your principal residence and sell it two years later. Your fraction would be 2/2, (two years as principal residence/two years ownership after January 2008). You would get the full tax break. All that time you owned it before 2008 wouldn't come under the new rules.
But let's say you buy the mountain cabin next month. For five years, 2008 through 2011, you use it only for vacations. After five years of vacationing, you move into the cabin full-time and sell two years later.
Let's be nostalgic and imagine the cabin's value increases sharply, so you actually have a capital gain to worry about. Your fraction would be 2/5, (two years as principal residence/five years ownership after January 2008). You would be able to claim only 40 percent of the tax break, or a maximum of $200,000 in capital gain tax-free if you're married, $100,000 if you're single.
Bette Gallo, president of Prudential Gallo Realtors in Rehoboth and Lewes, said she doesn't think the tax change would affect her market very much. "I guess the government is trying to close up all the loopholes," she said.
Congress's Joint Committee on Taxation estimates the change would bring in $16 million in just its first year -- not a lot of money by federal budget standards, but that's because it applies to just 12 months of gains. As more gain becomes taxable, that number would jump to $121 million by 2010 and continue growing by 16 to 22 percent annually, as those fractions described above grow smaller.
You can limit your exposure to capital gains tax by keeping good records (and receipts) for all the money you spend on home improvements made to your principal residence as well as to a vacation home. If the tax laws change, or if your gain exceeds the exclusion, you could need them to whittle down any tax bill you might owe for capital gains.
Money you invest in the house over the years for durable improvements, including major kitchen appliances, new heating or cooling units, room additions, a new roof or water heater, insulation, or a patio or sidewalk, can significantly trim the amount of capital gain that could be taxable when you sell. Money spent on repairs, such as repainting the house or repairing gutters, doesn't count, because the IRS says they don't add value to the house.
If you decide to upgrade to a better vacation home, tallying those receipts will be the only way to keep the tax bill down.
E-mail Elizabeth Razzi atrazzie@washpost.com.
