The major determinant here is the Jan. 1, 2009, effective date. "This time, it really is a prospective effective date," says Bob D. Scharin, senior tax analyst from the Tax & Accounting business of Thomson Reuters.
That means someone who buys a vacation home next year, ultimately converts it to a primary residence and then sells it will feel the full force of the new law. But if you've owned your second place for many years and convert and sell it soon after the new law kicks it, your tax bite won't be as much.
Buy a second home next year
Let's look first at the tax ramifications if you buy another home next year and use it for vacation getaways for 10 years. Then you sell your main home and move into the holiday retreat full time, where you live for another 15 years before selling.
Your total ownership period is 25 years, 10 as a vacation home and 15 as your primary residence. Fifteen divided by 25 equals 60 percent, the amount of time it was your main home. So if you made $250,000 profit on its sale, under the new law you can only exclude $150,000 from tax. You have to pony up capital gains taxes on the remaining $100,000 of profit.
But what if you already own a second home? That changes things in your tax favor. "Any time that you own the home before 2009 is not counted," says Scharin.
Second home you already own
Let's use the same circumstances as before, but shift the ownership and sale calendar a bit.
This time, you owned your home for five years before the new law kicked in and five years after Jan. 1, 2009. You still have 10 years of vacation homeownership and 15 years of living there as primary residence. But the new law doesn't count those five pre-2009 years of ownership.
So for tax purposes, your ownership calculation is five years as a vacation home and 15 years as your main home. During those 20 years, the property was your primary residence for 75 percent of the time, meaning now you can exclude $187,500 of your $200,000 profit, a tax saving of $37,500.
The IRS will issue details on the exact tax calculation formula, as well as new forms and work sheets, to help home sellers figure their precise tax bills. Tax software companies will be close behind with their versions.
Just how much money?As the second home conversion and sale examples show, the IRS will collect some additional revenue from the law change. The Senate Finance Committee estimates that it will amount to around $1.4 billion over 10 years.