Q. Say a couple has owned a vacation home for 20 years. They rented it out for a few years and used it for family only for the following 15 years. They sold their primary home three years ago and the vacation home is now their primary residence. Now they want to sell it and buy a larger home. What are the tax implications?
A. There are several issues to consider here.
Let’s take care of the easy part of the question first.
When you sell your principal residence, you may be able to exclude up to $250,000 of gain, or $500,000 if married filing jointly, if you meet the so-called ownership and use tests, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
“This means that during the five-year period ending on the date of sale, you must have owned the home for at least two years (the ownership test), and lived in the home as your main home for at least two years (the use test),” he said. “If the couple meets these two tests, they can exclude up to $500,000 in gain.”
Now let us look at the rental home.
Assuming when the couple sold their primary home they moved into their then vacation home, and if they lived in the home as their primary home for the last three years, they meet both the ownership and use tests for the second home, Kiely said.
“The fly in the ointment is the depreciation they took or could have taken after May 6, 1997 while the property was rented out,” Kiely said. “They may have to pay back or `recapture’ some or all of the depreciation they were entitled to take on the property.”
He said because you were entitled to deduct depreciation on the part of your home that you previously rented, you cannot exclude the part of the gain equal to any depreciation you deducted or could have deducted.
“This means that when figuring the amount of gain you can exclude, you must reduce the total gain by any depreciation allowed or allowable on the part of your home used for business after May 6, 1997,” he said. “This recaptured depreciation must be reported on Schedule D on your tax return.”
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Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.