Homes on beaches aren't treated differently from a tax perspective than any other house. However, if your beach home is a second home or an investment property, its sale could be subject to significantly higher taxes than a primary home would. With some advanced planning or some flexibility in how you use your sale proceeds, though, you can avoid or defer some or all of your tax liability.
Calculating Gains and Losses
The first step in planning for the sale of your beach house is to calculate your potential gain or loss. The IRS doesn't calculate losses by subtracting your purchase price from your sale price. You get to increase your purchase price by adding in the non-loan related closing costs you paid when you bought the property. You can also add in the cost of any capital improvements you made to the home. Some major repairs that extend the life of the home -- like replacing siding, re-plumbing, or putting on a new roof -- also count as capital improvements. Once you've figured out your total cost, you subtract that from your net selling price after paying the commissions, fees and closing costs at the sale. By projecting your taxable gain or loss, you can determine what tax strategy to use.
Selling at a Loss
When you sell your primary residence for a loss, there's essentially no need for tax planning. Losses on personal residences don't carry any tax liability and don't give you any tax benefit. As such, you can sell the home whenever and however you wish, knowing that the transaction will be completely tax-neutral.
When your beach home is your primary home, you're entitled to the same capital gains exclusion that you'd get for any other house. To qualify for the exclusion, you need to have used it as your primary home for two of the last five years, and you cannot have claimed the exclusion on any other home in the previous two years. If you meet these rules, up to $250,000 of any gain is tax-free if file a single return and up to $500,000 is tax-free if you're married and file a joint return.
Additional Personal Residences
With a second, third or ninth home, any profit you earn on the sale is subject to capital gains tax. Assuming you've owned the home for at least a year, the tax will be either 15, 18.8 or 23.8 percent, depending on your income. One tax planning strategy is to own the house for at least one year, ensuring you can pay these lower long-term capital gain rates. Another is to move into the house for two years, or to move into the house for long enough to get credit for two years of use as a main house if you've already spent some time using the home as a primary residence in the past few years. Bear in mind, though, that your ability to claim the exclusion will be limited by a calculation that divides the number of years you've used the house as a primary residence since 2008 by the number of years you've owned it. This can lead to a significant cap on properties that you've owned for a while. When these strategies won't work, your other option is to identify other assets that you can sell at a loss to offset the gain. The IRS lumps all of your capital gains together at the end of the year, so if you have a taxable gain of $100,000 on your house, you can offset it by selling off stock on which you've lost $100,000.
When your beach home is an investment property that you don't occupy, your tax calculation changes. If you have a gain, you'll still have to offset it or pay capital gains taxes on it, but if you have a loss, you'll be able to use it to offset other gains from investing. Unfortunately, you'll have to pay back any depreciation that you claimed at 25 percent. However, you can defer all of these taxes by using your proceeds to buy more investment property through a relatively complicated procedure called at 1031 Exchange. In a 1031 Exchange, you let the money from the sale sit with a third party who actually does the purchase for you. After your property sells, you have 45 days to identify a limited number of properties that you might buy and you have an additional 135 days to actually buy one or more of them.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.