It’s a holiday week so I’m re-posting popular stories from days gone by. This post from January of 2012 is about the tax consequences of winning the HGTV “Dream Home” giveaway.
When I started writing this piece, it was intended to be a simple post. As I was writing, I realized I would need more words to explain everything, so then it became a 3-part series. Then after the 3 parts were written I started thinking of other things I needed to consider, such as passive activity limitations and short-term rental rules, as well as local covenants. The series ended up at 6 disjointed and confusing pieces. Still, people loved the series and each of the posts is popular even now, more than 5 years later.
Here is part 1 of the series.
Originally published January 2, 2012
HGTV gave away a home in their “Urban Oasis” promotion last week (it was an apartment in the Trump Tower in Chicago) and they are giving away another home on February 17. The winners of those homes are always so happy on camera — but they may not be happy once it comes time to file their tax return.
Why? Because the value of the home is considered taxable income to the winner.
For example, in the Dream Home Giveaway next month, the winner gets a $2 million home plus $500,000 in cash. That’s $2.5 million of taxable income to the winner. They’ll be in the 35% tax bracket. $2.5 million x 35% = $875,000 in federal taxes. Meaning, even with the cash prize of $500,000, they’ll be $375,000 short.
Sell the Home to Pay the Tax, Owe More in Taxes!
The winners could always take the home, sell it, and then use the cash to pay the taxes. But if they do that, they’ll either a) owe short-term capital gains tax or b) have a non-deductible capital loss.
The winner of the $2 million home immediately sells it for $2.1 million. On their tax return, they’ll have to claim a $100,000 capital gain taxed at 35% (assuming that it’s sold less than 1 year after taking possession). So $2.6 million of total income ($2 million value of the house plus $100,000 gain plus $500,000 cash prize) taxed at 35%, which equals $910,000 of taxes. Their net takeaway after federal taxes will be $1.69 million ($2.1 million cash from sale plus $500,000 prize minus $910,000 in taxes).
If they sell the home for $1.9 million, they’ll have a non-deductible $100,000 loss on the sale and still be taxed on $2 million. Tax owed equals $875,000. Their net takeaway after federal taxes will be $1.525 million ($1.9 million sale plus $500,000 cash prize minus $875,000 in taxes).
Better to Take the Cash? Are There Other Options?
Most of these contests offer the option of taking a cash prize instead of taking the home. Is that a better option? What about taking out a bank loan or line of credit against the house? Or renting out the home? I’ll discuss tomorrow.