Warning: Tax Loophole for Second Homes Closing

Kiplinger ^ | Oct 12 2007 | Joan Pryde

[freedomdefender]

Folks who move into their second homes and later sell won't get as big a tax break as they may be expecting, thanks to legislation that Congress will pass this fall. A provision in a pending mortgage relief bill blocks homeowners from excluding all of their gain on a second home, even if the home is sold more than two years after it becomes their primary residence.

Here's how the change will work: Currently, you can sell your primary residence and exclude up to $500,000 of gain ($250,000 for singles) if you lived there for two out of the past five years. Then you can move into your second home -- either a vacation property or a home that you've been renting out -- and, if you make it your main home for two years, use the $500,000 exclusion again when you sell it. A House-passed bill would change this by taxing some of the profit on that second home. The amount taxed would be based on the portion of the time during which the taxpayer owned the home that the house was used as a vacation home or rented out. The rest of the gain remains eligible for the up-to-$500,000 exclusion, as long as the two-out-of-five-year usage and ownership tests are met.

The good news: There is some transitional relief. The tightening will apply only to sales after 2007. Plus any periods of personal or rental use before 2008 are ignored for purposes of the provision.

For example, say a couple buys a second home in 2006 to use as their vacation home. Three years later, in 2009, they sell their primary residence and move into the vacation home, making it their main home. They sell that home in 2011, realizing a gain of $200,000. Under the proposal, 20% of the gain, or $40,000 (one year of nonqualified use after 2007 divided by five years of ownership), isn't eligible for the capital gains exclusion. The other $160,000 can be excluded from income because the two-year usage and ownership tests were met.

The mortgage relief bill containing this loophole closer is designed to help homeowners caught by the downturn in the subprime mortgage market: Under current law, if your lender forgives a portion of unpaid mortgage debt, you must pay income tax on the forgiven amount to the extent that it exceeds the value of your home, except to the extent you are insolvent. The pending bill would let homeowners exclude those amounts from income. The measure also extends through 2014 the tax deduction for private mortgage insurance, which is scheduled to expire at the end of this year. The loophole closer was added to offset revenue losses from the relief provisions. Because the real estate industry doesn't oppose this tax change, it's a sure bet to pass the Senate and be enacted before Congress adjourns for the year.

Ki

[freedomdefender]

Doug: As a real-estate specialist, any thoughts on this coming change?

[doug from upland]

I don’t know how big an impact this will have because I don’t know how many people are actually doing this. I guess it must be significant enough to craft legislation. Could it have an impact on the purchase of second homes? It may have some impact. More good news for the industry and the economy, huh?

[rb22982]

So is PMI deduction going to be allowed on mortgages closed on before 2007 with this bill? Seems ridiculous that only people who VERY recently got mortgages can qualify.

[prov1813man]

I imagine there will be an impact on homes in resort/retirement areas like Florida. Buying a second home for vacationing now and residence later has just become a bit less attractive.

[Fido969]

Keep track of rental and vaction time? Too complicated.

My prediction: DOA.

[SubMareener]

Obviously, you have never lived in New York and had to wade through the telephone-book-thick New York Income Tax instruction book. “Too Complicated” is not part of DemocRAT vocabulary.

[narby]

This is disaster. This is an incentive for people to sell second homes fast. There is no faster way to totally crash the value of housing than people who now own two homes downsizing to one. That will result in a permanent glut of housing that will never be sold.

This sucks. If this occurs it's time to sell out and rent.

[narby]

This is a really stupid move. Typical Democrat move. They're seeking more money, but to do it they're going to force people to sell second homes now. That in turn will crash the housing market like we haven't seen before. A crashed housing market will me no profits on sold houses, so the government won't get the tax money they're seeking.

Totally stupid.

[Leftism is Mentally Deranged]

Another thing to complicate the tax code. Most people won’t care because it doesn’t apply to them. Then the politicians tighten it more so that it applies to more people.

[Garden Island]

This is a TAX INCREASE. But President Bush will VETO it. Our republican govenor Lingle of Hawaii, who is somewhat of a moderate, vetoed an attempt by the local Dem thieves to withold more state capitol gains on real estate transactions late last year.

Thanks to President GW Bush, and Reagan, it is pretty much common knowledge that higher taxes damage the economy, and lower taxes increase gov revenues.

[p. henry]

I think it will depend on the local market. I live in San Diego. Very of the homes in my neighborhood are “second” homes. On the other hand, significant percentages of the residences in certain coastal areas and downtown San Diego are vacation homes and/or rental investment properties. If this legislation becomes law, the owners of those properties will no longer be incentivized to hold them until they have lived in them for two years and one of the incentives for buying a second home will have been removed. I doubt these effects will have much immediate impact because no sane person is buying or selling in these markets today. Over the longer term, however, this change will reduce demand and therefore delay the recovery in these areas.