A taxpayer excludes the gain (up to $250,000 or $500,000) on a second or vacation home by moving into the home and occupying it as a primary residence. He will have to treat any depreciation taken as “unrecaptured Section 1250 gain” when the rental property is converted to residential use.
The parents reduced their taxable income by $5,000 by excluding the taxable gain on their second or vacation home. Since the parents income was taxed at the 30% tax bracket, the income reduction may decrease their income taxes by $1,500 ($5,000 x 30%).
If you are in a combined (federal, self-employment, and state) tax bracket of 30%, you could reduce your taxes up to $300 for every $1,000 of income reduction by excluding the taxable gain on a second or vacation home.