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The tax-code-defined vacation home rules come into play when you have both rental and personal use of a home. Thus, you can have tax-code-defined vacation homes in the city, in the suburbs, and in recreation areas. 

If you have no combined rental and personal use of the home, the rules are easy. The property is one of the following: 

  • Principal residence 
  • Second home 
  • Rental property 

But when you have both rental and personal use of the home, your tax life gets more complicated because you have entered the tax code’s vacation home section. In this situation, the property in a more complicated way is one of the following: 

  • Principal residence 
  • Second home 
  • Rental property 

If it’s a principal residence, then the $250,000/$500,000 home sale exclusion is available when you sell.  

If it’s simply a second home, you can’t use the exclusion and you pay taxes at capital gains rates—and you may suffer the net investment income tax (NIIT) as well. 

If it’s a rental, you face the capital gains rules, NIIT, unrecaptured Section 1250 gain taxes, and release of some (if grouped) or all (if not grouped) passive activity suspended losses. 

When you have rental use after 2008 and then convert the rental to your principal residence, you must use a rental/residence fraction to determine how you will be taxed. 

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