Clayton & Clayton Real Estate Blog

Rules differ for vacation homes and rental properties, and whether a second home is designated as one or the other can influence seller options for financing as well as carry tax implications for both buyer and seller. Options for vacation homes, such as waterfront real estate, may not be clear cut. When it comes time to sell an Ortley Beach vacation home, there also are tax implications that hinge on whether the property was ever rented, for how long, and how it was used by the owner and the owner's family. Numerous variables exist.

A second home, just as a primary residence, is considered a capital asset, subject to either short-term or long-term capital gains based on the length of time the home was owned. There are also possible tax consequences and the property can be treated differently if it was ever rented or used as a primary residence; and whether or not it qualifies as a "like-kind" or tax-deferred 1031 exchange.

It all depends on individual circumstances, and the advice of a professional tax adviser as well as an experienced real estate agent are invaluable.

Personal Use vs. Rental

There are three rules that determine the property's status as a second home:

1. A vacation home may be rented to another party for no more than 14 nights in any single year without having to report rental income, no matter what the amount received.
2. If the property is rented more than 15 days a year, and the owner uses it less than 14 days or less than 10 percent of the number of rental nights, it is considered investment property and all income must be reported. In this case, mortgage interest, taxes, insurance, upkeep, maintenance, utilities and any management costs are treated as business expenses. Time spent at the property for purposes of repair and maintenance don't count as personal days, but owners who use this option must be able to document the type of work performed and the actual time spent.
3. A third option allows rentals of 14 nights or more in any single calendar year as long as the owner also occupies the home for more than 14 days or 10 percent of the number of days the property is rented, whichever is greater. Members of the owner's family, in this case, are also considered "owners" unless they are charged fair market rent. In this scenario, the home is treated as a personal residence, not a business.

Selling a Second Home

As with any time a homeowner sells a home, any taxes due at time of sale are based on the difference between actual cost plus authorized expenses during the ownership term—the adjusted cost basis—subtracted from the net sales price. Certain expenses related to selling the property, including the full amount of any real estate commission paid, service to reduce the net sales price.

Whether or not a vacation home is classified as a second home or a rental property, and whether any capital gain is short or long term will determine the actual amount of tax due, if any.

Financing Options

Owner financing for all or part of the selling price can be an advantage for both seller and buyer. Taking back a portion of the sum as a second mortgage, payable over time, can make the property easier to sell, and will reduce any potential capital gain that must be reported in a single year.

In cases where the capital gain amount on a second home is substantial, the ability to stage payments over multiple years may be beneficial enough to outweigh any risk involved. Tax liability accrues only to the portion of principal received in any single tax year.

As with any real estate transaction, the advice of a reputable tax adviser and accountant will help to make the options clear, and there is no substitute for experience and expertise.