By John Waggoner
From Kiplinger’s Personal Finance
When Amiee Lamont and her husband Ray Struble sold their rental house in Fairfax, Virginia, they got a six-figure surprise from their accountant.
“We got a good-sized tax bill,” LaMont says. And how: They paid about $172,000, she says.
Given the red-hot real estate market, you, too, could have a big tax on your gains when you sell.
The type of tax surprise you get depends, in part, on how you’ve used your second home. If you or a family member have lived in it 14 days or fewer per year and gotten a fair market rent from it, you have a rental property. If you’ve frolicked on the beach in front of your home for more than two weeks, it’s a vacation home. This brings us to our first tax surprise.
Surprise No. 1
When you sell your primary residence, you get a huge tax break. Couples filing a joint return can exclude $500,000 of the gain from taxes, while single filers can exclude $250,000. You don’t get that tax break for a vacation home. You’ll pay federal and state capital gains taxes on your entire profit. (If the home is in another state, you may wind up paying taxes in both states.) The same is true for a rental property.Federal capital gains tax ranges from zero to 20 percent. High earners could end up paying an additional 3.8 percent Medicare surcharge. Let’s say that you bought your vacation home for $250,000 and sold it 10 years later for $850,000. You’d owe capital gains taxes on your $600,000 gain. Uncle Sam’s 20 percent cut would be $120,000.
Surprise No. 2
You’ll need some records from the entire time you owned the house. Why? Because you can deduct the cost of major improvements you’ve made over the years. To get those deductions, you’ll need to document your improvements.Surprise No. 3
If you have rented your vacation home, you can typically get an annual deduction for depreciation—basically, wear and tear on the building. Real estate is depreciated over 27.5 years. This applies only to dwellings, not land. If you paid $250,000 for just the house, you’d get a deduction for $9,091 a year for the time you’ve owned it, up to 27.5 years. That’s not bad, that is, until you sell it. You’ll have to pay income taxes on your depreciation (capped at 25 percent) when you sell. So, if you claimed $50,000 of depreciation over the years, you’d pay ordinary income tax, up to 25 percent, on $50,000.Surprise No. 4
A big gain on your real estate could make your Medicare part B premium and your Medicare Part D prescription drug premium much larger, thanks to the income related monthly adjustment amount (IRMAA). Your IRMAA payment depends on your income, and the higher the income, the higher your Medicare Part B and Part D payment, says Nicholas Bunio, a financial planner in Downingtown, Penn., who says profit from your home sale will be included in your income calculation for purposes of IRMAA. A peculiarity of IRMAA is that it looks back at your returns from two years ago, not your current income. So, if you sold a house in 2022 for a huge profit that increased your premiums in the 2024 tax year, you probably won’t have to pay the surcharge in 2025.
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