Selling your second home in the midst of a buyer's real estate market may cause you to sell the home at a loss. And to make matters worse, the IRS only allows you to deduct the loss if you use your second home as a rental or for other investment purposes. But regardless of whether you own the second home as an investment or for personal use, you can always offset your other capital gains with the loss.
Calculating Tax Loss
You should always calculate the resulting capital loss on the sale of your second home and report it on your Schedule D, which requires that you initially determine what your tax basis in the second home is. Your tax basis is equal to your acquisition or construction costs, most of your closing costs and the expenses you incur making permanent home improvements to the home prior to its sale. If you sell the home for less than your tax basis, calculate your loss as the basis minus the sale proceeds.
Investment Depreciation Consideration
If your second home is an investment, such as a rental property, you must reduce your tax basis for the cumulative amount of depreciation deductions you claim on the home up to the date of its sale. For example, if you purchase a rental home in 2009 for $200,000 and claim two years of depreciation deductions totaling $14,242 up to the date of sale in 2011, you must reduce the tax basis to $185,758 for purposes of calculating your loss on the second home.
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Reducing Capital Gains
When you prepare your tax return after the close of the tax year, the IRS requires you to report all capital asset transactions on a Schedule D, irrespective of whether the result is a gain or loss. Since you calculate your capital transactions separately from your other sources of income, you can net all transactions together to ultimately arrive at one net gain or loss for the year. Therefore, the tax loss on your second home reduces the capital gains you report from other asset sales, regardless of whether the gain relates to the sale of a different home, stocks, bonds or even your stamp collection.
Annual Loss Deductions
The IRS provides an additional tax benefit for some of your capital losses in the form of a $3,000 annual deduction from your other non-capital taxable income. However, this deduction is only available for your investment property losses. Therefore, if your second home is personal-use property, a deduction is unavailable for the loss that remains after eliminating capital gains with it. But if you use the second home for investment purposes, you can claim the deduction. Although you can carry excess capital losses forward to reduce future capital gains, only the investment losses you carry forward are eligible for future $3,000 deductions.