Capital Gains Tax and the Vacation Home: Do You Sell Your Vacation Home After Divorce?

If you own a vacation home and you are about to get a high net worth divorce, you may be wondering if you should sell it. If you do sell it, what are the tax impacts? Keeping the vacation home in a divorce also has tax implications, and it may have other downstream effects that could involve your children, extended family and financial legacy.

It’s important to review the situation carefully with an experienced Massachusetts divorce attorney or attorney mediator to understand how your financial situation, retirement and estate planning goals and family relationships will align with your decision. There are benefits and disadvantages of keeping or selling the vacation home.

Keeping the Vacation Home: Deferred Tax and Estate Planning

The major benefit of keeping the vacation home is that it remains an asset that can be used for recreation and/or as a rental property and can be passed on to heirs free of capital gains tax. The “stepped up basis” rule means that heirs who inherit the property without jointly owning the property will receive the property at its full fair market value at date of death, so they won’t have to pay capital gains tax on the appreciation. This strategy allows you to take care of your heirs and defer capital gains tax on a property that might otherwise be subject to significant tax upon the sale of the home. Unfortunately, we commonly see people who are gifted a vacation home before the death of a parent and in those instances there is no step up in basis, which means the person being gifted the property takes it at the fair market value at the time it was purchased, which can result in significant capital gains when the property is sold. This is something that should be considered when the asset is being divided so that the true value of the property is being considered after any potential gains are paid.

Typically, it is more advantageous to sell the primary residence in divorce because the primary residence qualifies for a capital gains tax exemption in divorce. This means that you can each exclude $250,000 from the profit you make on the sale of your home, or if you are still married at the time of the sale you may be able to exclude up to $500,000 of any potential capital gains. To qualify for this exclusion you must have been living in the residence for at least 2 years. Usually, the vacation home doesn’t qualify for this exemption.

The vacation home can also represent emotional attachments, especially for children who may have spent summers there during childhood. Some divorcing spouses choose to keep the vacation home after divorce and agree upon a usage schedule and how to share upkeep costs. This can be outlined in your divorce settlement.

Occasionally one spouse will convert the vacation home to a primary residence which can take advantage of the capital gains tax exemption if the home is transferred between spouses before divorce and the spouse lives there for two years before selling. The property may also be converted to a rental property which provides income for one or both spouses and also defers the tax that would be owed on the sale. If spouses choose to remain co-owners of the vacation property either for recreational, rental purposes or both, it’s important to be cognizant of the risks of this arrangement and to take extra care when drafting the divorce settlement outlining responsibilities, usage and maintenance costs.

Selling the Vacation Home: Making a Clean Break, Raising Money for the Divorce Settlement

People often sell the vacation home after divorce because they don’t want to remain tied to their ex-spouse and extended family. The vacation home may not belong to your spouse and you alone, your family may have a share in the home. If you don’t get along with your ex or your extended family it may be time to make a clean break. The risks of keeping a vacation home “in the family” can be seen in the conflict surrounding Senator Diane Feinstein and the daughters from a previous marriage of her deceased husband. Senator Feinstein and her daughter are disputing assets held in trust, including a beach house that Blum’s daughters want to keep using, and Senator Feinstein wants to sell. One issue with continuing to share the vacation home with your ex is that you can’t control who inherits that asset if your ex remarries or has children from a previous marriage. The benefit of working with an experienced attorney-mediator is that a divorce mediation is an agreement that is worked out with the buy-in of both parties who have a mutual interest in reducing and forestalling conflict.

Another reason people often sell a vacation home is because it raises cash for the divorce. Without sufficient liquidity ex spouses may not be able to afford to buy each other out of other assets, business interests and to pay off debts. If you are still paying a significant mortgage on a vacation or beach house, this could also affect your credit and make it more difficult or expensive to get a new mortgage loan or other kind of financing, especially on a reduced income after a divorce. Sometimes it’s simpler to just move on and leave any dealings with your ex or in-laws in the past.

Interest Rates and Property Value

When you are considering whether to sell or keep the vacation home, you must also assess the current market. In the current landscape, buyers and sellers face increased interest rates and stagnating property values. Prices are still steep but a loan may be more expensive if you want to buy a new home or refinance an existing one. Depending on when you purchased your home, the home could have appreciated, but your buying power may have decreased relative to the property values in your area. Divorcing spouses may choose to co-own a home to keep their current interest rate and avoid paying capital gains tax. You also have to weigh the costs of refinancing a larger home, like the vacation home you shared with your spouse, at higher interest rates against selling the home and downsizing to a home that is less costly and expensive to maintain. If you have not owned the property for a long time, the capital gains tax may not be significant. It may be possible to buy out your spouse and have title transferred to you without refinancing the home. However, in this situation, you or your ex will remain responsible for the mortgage which could be contentious if one party experiences any financial instability that could cause them to miss mortgage payments.

As with many decisions about marital assets, the decision about selling the vacation home boils down to the financial advantage of your decision and the extent to which you want to remain tied to your ex-spouse. If your relationship with your divorcing spouse is not amicable it may be better to cut the cord. If you can continue to co-own a property and perhaps sell at a later date or buy out a spouse without refinancing the home, this could be a financially smart move. It may also be smarter to sell a large property with high maintenance costs and use the money to downsize and move into a smaller property.

It’s important to consult with an experienced Massachusetts divorce attorney or attorney-mediator to craft a divorce settlement that reflects your needs and anticipates any problems down the line. At Mansur Law Group we have extensive experience working with divorcing spouses with complex assets to create highly specific and tailored divorce settlements, or to advocate for you in court if necessary. These divorce agreements take into account more than just the divorce, but also financial legacy, inherited property and estate planning. Please contact us today for a consultation about your situation.