Prices of vacation homes in most parts of the nation have soared in the past several years. Sellers today face difficult tax issues.
Q: My wife and I purchased a small cabin as a vacation home several years ago, and now we are planning to put it up for sale by the end of this year. We should have a net profit of about $105,000 after the sale closes and all expenses are paid. How will the profit be taxed? Will we be allowed to use the same tax loophole that lets married couples keep up to $500,000 in profit from the sale of their primary residence tax-free, even though we have never used the cabin more than two or three months a year?
A: Sorry, but you almost certainly will owe at least some taxes on the profit from the sale of your vacation home.
It's true that the Internal Revenue Service allows most married couples to keep up to $500,000 in profit tax-free when they sell their primary residence (the limit is $250,000 for single filers). But your letter states that you have used the cabin only two or three months per year, so there's no way that you can argue that it's your personal residence and qualify for a tax exclusion.
Instead, you'll probably owe federal taxes on your vacation-home profit based on the long-term capital-gain rate of 15 percent.
And if you have taken depreciation deductions on the property through the years because you rented it out to tenants when you weren't there, you'll owe up to 25 percent more in federal taxes on the total of the depreciation write-offs that you have claimed.
Because you don't plan on putting the cabin up for sale until the end of this year, you and your spouse should first spend an hour or two with an accountant or other tax expert to discuss your plans.
A good tax pro should be able to recommend several ways to help keep the tax bite as painless as possible.
Q.: I've heard that it's against the Muslim faith to borrow money. Does that mean their religion prevents them from taking out a mortgage?
A.: Conservative Muslims shun American-style home loans because Islamic law (known as Shariah) essentially considers it a sin to pay or receive interest. But several U.S. banks have painstakingly developed special loan programs that Muslim scholars say adhere to Shariah, in part because lenders don't want to miss out on the profit potential of our nation's fast-growing and relatively wealthy Muslim population.
One type of program involves a 10-year lease with an option to buy. Under it, the Muslim client chooses a property and makes a 20 percent down payment. The rest of the purchase price is financed by a bank or a nonprofit that takes out a conventional mortgage in its own name.
The Muslim then sends the bank a monthly rent check that the bank can use to make its own mortgage payments and earn a profit.
The Muslim has the right to purchase the property any time during the course of the 10-year lease, or can extend the agreement for an additional seven years.
If the Muslim customer decides to move early, he or she can exercise the purchase option and simultaneously sell the home to a new buyer. Depending on the terms of the original agreement, the resale profit is either kept entirely by the seller or shared with the bank or nonprofit group.