A second home may serve as a vacation escape, a rental property or both. If you are planning to sell a second home in the near future, there is a new tax development to consider.
Generally, the Internal Revenue Service allows for any gain from the sale or exchange of property held for productive use in a business or for investment to be deferred if all of the proceeds are re-invested in "like-kind" property within 180 days of the sale or exchange. In the past this favorable treatment did not apply to personal residences that were not rented. In Revenue Procedure 2008-16 which was released in February 2008, the IRS provided guidance whereby a "dwelling unit" will now qualify for this favorable treatment if certain conditions exist, which will now allow more taxpayers to benefit from this opportunity when selling a vacation home.
A dwelling unit is defined to include real property improved with a house, apartment, condominium or similar improvement that provides basic living accommodations including sleeping space, bathroom and cooking facilities.
In order to qualify for this favorable tax reporting position, several requirements apply:
Let's assume a taxpayer acquired an oceanfront vacation residence ten years ago for $750,000 and is planning to sell the property in two years for $1,500,000. If the taxpayer is subject to a combined federal and state rate of 20%, $150,000 will be due. However, if the taxpayer reduced their personal use of the property as outlined above and reinvested the proceeds in "like-kind" property, they could eliminate all of the $150,000 of taxes related to the sale in the current year.
If the taxpayer fails the tests related to the replacement property after reporting the transaction as a qualified "like-kind" exchange, they must amend their prior return and report the gain.
If you are planning a property sale or purchase, utilizing a like-kind exchange could result in significant tax savings. For more information, contact Dwayne Holt or your Beers + Cutler partner.