Owners of Leavenworth vacation homes or people considering buying a vacation home should be aware of some recent tax law changes that may effect you.
Before I go too much further, I have to state this obvious disclaimer.
I am not a lawyer, CPA, or tax professional. Please use the following information as a starting place for your discussion with a tax professional.
As many folks know, the profits on the sale of a primary residence have been excluded from income tax or capital gains tax for many years - up to $250,000 for an individual or $500,000 for a couple. For most of us, that means we only pay local and state excise taxes when we sell real estate, because the real estate that most folks buy and sell is limited to their primary residence.
When you buy or sell a vacation home or an investment property, no such exemption exists. (Unless you are using a 1031 tax exchange and buying more real estate - which you probably should.)
However, some folks have figured out a way to avoid paying taxes on the sale of the vacation home as well. (Until now.)
Vacation home owners could sell their primary residence and claim the exclusion. Next they could move into their former vacation home and claim it as their new primary residence. They can't sell it right away, but after 2 years as a primary residence they could in fact sell it without facing any tax liability (up to the $250/500,000 limits).
Well folks, those days are gone.
As part of the Housing Assistance Act of 2008, designed to help homeowners facing foreclosures, the taxes due will now be based on the ratio of years it was a vacation home compared to the years it was a primary residence. (However, the years prior to 2009 will not be counted)
George and Martha live in Virgina and bought a vacation home in Cashmere with a nice Cherry orchard in 1996. In 2012 they decide to sell the Virginia home and move to Cashmere for their retirement. In 2020 George decides that cherry trees are too much work and decides to sell the farm.
The years between 1996 and 2009 are not recorded as far as tax liability.
The years 2009-2012 are not exempt from tax liability. (3 years)
The years 2013-2020 the house was a primary residence and are exempt. (8 years)
Therefore the tax liability would be on 3/11 ths of the gains from the sale of the house.
One possible loophole:
According to an article on Bankrate.com owners of multiple homes may be able to beat the system. There is a provision that allows you to reverse the original process and not pay taxes.
The new scheme works like this:
Move to your vacation home in 2009 and live in it for at least 2 years and sell it as your primary residence. Then move back to your original primary residence for at least 2 years and sell it.
Yes, this all gets very complicated very quickly, so consult your tax attorney or a CPA before you even start to make a decision on this.
Here is one attorney's take: Corporate Finance Blog