Tax Increases on Second Homes and Investment Properties

Up until now, if you sold your principal residence, you could pocket up to $250,000 in profit, tax-free (or $500,000 if you are married filing taxes jointly) as long as you were living in it for at least two of the last five years. In other words, if you owned rental or investment property and you moved in and used the property as your principal residence for at least two of the last five years, you could receive substantial profits tax-free upon the sale of the property. You could sell your home and move into your vacation property or rental unit for just two years, and still avoid paying capital gains tax.

Well, lawmakers have finally caught on. If you plan to buy, sell or live in an investment or rental property that you own after January 1, 2009, you will still be able to receive some of the profit from the sale of your rental or investment property tax-free, but not all of it.

The new tax scheme involves prorating the profit between the time you rented the property and the time you lived in it. If you rented out your property for a year (non-qualified usage, in IRS jargon), and then lived in it for three years (qualifed usage), and made $200,000 profit when you sold it, then 1/4 of your profit is subject to capital gains tax, and 3/4 is not. Anyone buying investment property that they intend to reside in for any period of time should speak with their accountant or tax professional immediately to see how these new rules will impact them!