Warren Buffett Bought a California Beach House for $150,000. When He Sold It, the Tax Hit Could Have Reached $2.7 Million — What Vacation-Home Sellers Should Know

Warren Buffett once purchased a California beach house for $150,000 and kept it for decades, only to face a tax burden far larger than what most homeowners ever encounter. The reason the profit became so costly points to a hidden issue that can affect nearly any second-home sale.

According to GOBankingRates, Buffett bought the 3,588-square-foot oceanfront property in Emerald Bay, Laguna Beach, for $150,000. Because Buffett lives in Nebraska, the house functioned as a second home, and that designation shaped the taxes tied to its eventual sale.

The property did not move quickly. MPA reported that it was priced at $11 million in early 2017, then lowered to $7.9 million by September 2018.

In October 2018, the Orange County Register reported that the home sold for $7.47 million. The Real Deal said that figure was 32% below the asking price.

Even at that discount, a University of Maryland professor estimated the home had produced a 9% compounded annual return. Long-term appreciation like that is exactly what can make a vacation-home sale so expensive at tax time.

How a $150,000 House Can Lead to a Seven-Figure Tax Bill

Buffett’s actual tax liability has not been made public. To illustrate the potential impact, 24/7 Wall St. created an estimate using the reported purchase and sale prices. The calculation assumes no renovations and no selling expenses, and it uses current top tax rates, which may not match the rules that applied at the time of sale.

Under that estimate, Buffett may have owed about $2.7 million, or 37% of the gain. That is roughly 18 times what he originally paid for the house, while the federal portion alone comes to about 11 times the purchase price.

Selling expenses would reduce the total somewhat. If those costs were 5% of the sale price, the combined estimate would fall to around $2.6 million.

Why Vacation Homes Are Taxed So Heavily

Federal long-term capital gains are generally taxed at 0%, 15% or 20%, depending on income. Because the entire gain is recognized in one year, a sale can push a taxpayer into a higher bracket.

The 3.8% net investment income tax adds another layer. It applies to the lesser of your net investment income or the amount your income exceeds $200,000 for most single filers, or $250,000 for joint filers. Because gain on property not used in a business counts as investment income, a vacation home sale can be subject to this tax.

By contrast, the main-home exclusion can protect up to $250,000 of gain, or $500,000 for most married couples filing jointly. To qualify, you must own and use the home as your principal residence for two of the five years before the sale. A second home does not qualify.

California also taxes gains from California real estate even when the seller lives elsewhere. A nonresident calculates tax as though they lived in California and then applies that effective rate to the California source portion of income, according to FTB Publication 1100. The top rate is 13.3%, made up of a 12.3% bracket plus a 1% mental health services tax on income above $1 million, according to HCO.

Under FTB Form 593, the buyer or escrow company generally withholds 3 1/3% of the sale price at closing for individual sellers. A seller may instead elect withholding at 12.3% of the gain. A sale of a principal residence is exempt, but a second home is not.

Your home state may offer some relief. On Nebraska Form 1040N Schedule II, the credit for tax paid to another state is limited to the smallest of three figures: Nebraska’s own tax, a proportional calculation, or the amount actually paid to the other state.

Six Questions to Raise With a Tax Professional Before Selling

1. Basis records: Improvements may increase your cost basis and reduce your gain, but you need documentation to support them. Routine repairs usually do not count.
2. Holding until death: Heirs generally receive a basis equal to fair market value at death, which can erase income tax on appreciation. Estate tax is separate, and if the home is given away during life, the original basis carries over.
3. Donating it: A gift of appreciated property to charity can avoid tax on the appreciation and may allow a deduction at fair market value, subject to IRS limits. Gifts above $5,000 generally require a qualified appraisal and Form 8283, Section B.
4. Installment sale: You can report the gain as payments arrive, spreading the tax over multiple years. Interest paid by the buyer is taxed as ordinary income.
5. Rental use and a 1031 exchange: A tax-deferred exchange into similar investment property may be possible, but the rules are strict. Under the safe harbor described by IPX, the property is generally rented at fair market value for at least 14 days in each of two years, with personal use limited to 14 days or 10% of rental days, whichever is greater.
6. Turning it into a main home: Years when the property was not your principal residence reduce the exclusion proportionally. Moving in shortly before selling does not erase prior appreciation.

Check the Numbers Before You Put the Home on the Market

Begin with your purchase documents and records of improvements, then estimate the gain. After that, determine which federal and state tax brackets apply, including any surtax. A vacation-home sale can quietly take a large bite out of a retirement plan, and many of the available strategies only work if they are arranged before the sale. This is general information, not tax advice, and rules can change, so it is wise to bring your numbers to a tax professional first.