Lisa Mailhot | May 19, 2025
Buyers
No capital-gains exclusion? Big ouch. When you sell your primary residence, you’re entitled to a generous tax break—couples filing a joint return can exclude $500,000 of the gain from taxes, while single filers can exclude $250,000. But when it comes to vacation or rental properties, the IRS doesn’t offer the same kindness.
You’ll be taxed on your entire profit—federal and state capital gains taxes apply, and if your vacation home is in another state, you might be hit twice. Federal capital gains tax rates can reach 20%, and those with higher incomes may also be subject to an additional investment-related surcharge of 3.8%.
Let’s say you bought a vacation home for $250,000 and sold it a decade later for $850,000. You’d owe tax on the $600,000 gain. Just the 20% federal tax alone would cost you $120,000.
Also, if you've owned the home for less than a year, be prepared: “your gain will be taxed as ordinary income, which can be as high as 37 percent.”
Old receipts and invoices may seem like clutter, but they could save you thousands. To reduce your capital gains tax, gather documentation for major improvements—“Things have to be general improvements—a new kitchen, bathroom, things like that,” advises CFP Michael Hansen.
Why does this matter? Because those improvements increase your cost basis, reducing your taxable gain. If you built a $40,000 addition and replaced a roof for $20,000, your cost basis increases to $310,000. That could lower your tax liability from $120,000 to $108,000. Worth the paperwork? Absolutely.
If your second home was ever used as a rental, there’s a good chance you took advantage of yearly depreciation deductions, which reduce your taxable rental income. However, when you go to sell the property, those deductions are essentially “reversed,” and you’ll have to pay back a portion in taxes—potentially up to 25% of the total depreciation you claimed. It’s a twist that catches many off guard after enjoying years of tax benefits.
That big gain from selling your property might come with an unexpected consequence: higher healthcare premiums. Medicare uses a special formula called IRMAA (Income-Related Monthly Adjustment Amount) to determine whether you should pay more for your Part B and Part D coverage—and it bases this on your income from two years earlier, not the current year.
So, if your home sale dramatically increased your income in 2023, you might find yourself paying significantly more in 2025—even if your income has since returned to normal levels.
While you can’t dodge capital gains taxes entirely, there are a couple of ways to ease the burden.
If you’re open to switching residences, moving into your second home and living there for two of the past five years could make it eligible for the same capital gains exclusions as your primary home.
Another potential route? A 1031 exchange. This IRS rule allows owners of investment property to swap it for a “like-kind” property, deferring taxes on the profit. Keep in mind, though, that the replacement property must be held for a reasonable amount of time—typically at least two years—if you want to avoid triggering the very tax you're trying to postpone.
Of course, if you're already weary of landlord duties or property maintenance, swapping one investment property for another might not offer much relief—just a different version of the same responsibility.
Selling your vacation or rental property can be a great financial move—but only if you plan wisely and avoid unexpected tax shocks. Whether you're upgrading, downsizing, or just ready for a new lifestyle, staying informed can help you walk away with more of your hard-earned equity.
If you’re considering a move in Orange County or curious about how to make the most of your real estate investments, Whitestone Real Estate is here to guide you every step of the way. Reach out—we’ll help turn your property goals into smart, profitable moves.
Reference: Waggoner, J. (2025, May 19). Selling Your Vacation Home? Watch out for These Tax Surprises. Kiplinger’s Personal Finance. Tribune Content Agency.
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