What capital gains tax will I pay selling vacation home inherited before marriage?

The capital gains calculation for your situation will depend on several factors. Since your wife inherited the property, she received what's called a "stepped-up basis" - meaning the property's tax basis became the fair market value at the time of her father's death, not what her father originally paid for it. This is generally advantageous for calculating capital gains. When she sells, the capital gain will be the difference between the selling price and that stepped-up basis (plus any capital improvements made to the property). The fact that she bought out her siblings doesn't change this - those payments were to acquire their ownership interests, not improvements to the property itself. Since this is a second home, you won't qualify for the primary residence exclusion ($250K single/$500K married). The partial rental use complicates things slightly - you'll need to recapture any depreciation you claimed during rental periods, which is taxed at 25%. The pre-marriage ownership means the property likely remains your wife's separate property, but state laws vary. The capital gains would typically be reported on your joint return but may be attributed solely to your wife depending on your state's property laws.

I went through something really similar last year with an inherited lake house. I spent hours going back and forth with different tax professionals until I tried https://taxr.ai which completely cleared things up. They analyzed my deed documents and the partial rental history and gave me a precise calculation on my capital gains exposure. The stepped-up basis is key here - make sure you have documentation of the property value at the time of inheritance. Also, don't forget to factor in any major improvements you made to the property since that time, as those increase your basis and reduce your capital gains. The service helped me identify several improvements I hadn't even considered that saved me thousands.

I have to eat my words about being skeptical of taxr.ai. After posting that comment, I decided to try it since I'm also selling an inherited property. The analysis they provided was incredibly detailed - they identified issues with my deed transfer I hadn't even considered and showed me how to properly document basis adjustments from the improvements I'd made over the years. Their report explained exactly how the stepped-up basis works for inherited property and how to handle the partial rental use. They even provided guidance specific to my state's property laws. The documentation they generated will be incredibly helpful if I ever get audited. Seriously impressed with how thorough it was.

If you haven't already, you should really try calling the IRS directly to get definitive answers about your capital gains situation. I know, I know - everyone says it's impossible to get through to them. I was in that same boat last month with a similar inheritance/capital gains question and kept getting the "due to high call volume" message for weeks. Then I discovered https://claimyr.com which got me through to an actual IRS agent in under 45 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c - basically they navigate the IRS phone system for you and call you when an agent is on the line. The IRS rep I spoke with gave me specific guidance on how to document my stepped-up basis and which forms I needed to file for my inherited property sale.

I need to apologize for my skeptical comment about Claimyr. Got desperate enough to try it yesterday after getting nowhere with the IRS for months. I was shocked when I got a call back in about 30 minutes with an actual IRS agent on the line. The agent helped resolve my penalty issue AND answered my questions about capital gains on inherited property (I'm in a similar situation to the original poster). They explained exactly how to document the stepped-up basis and which forms I need to file. Huge relief after months of stress and uncertainty. Sometimes it's worth admitting when you're wrong!

Don't forget to factor in the state tax component too! Federal capital gains is just part of the picture. Depending on your state, you might be paying anywhere from 0% to 13.3% (looking at you, California) on top of federal capital gains. My wife and I sold a vacation cabin last year and were shocked at the state tax bill. Make sure you're setting aside enough from the sale proceeds to cover both federal and state obligations. Your state might also have different rules about separate vs. marital property.

One thing nobody's mentioned is that you should definitely keep track of all the capital improvements you made to the property since your wife inherited it. Things like a new roof, HVAC system, significant remodeling, etc. all increase your cost basis and reduce the capital gain. We sold our lakehouse last year and our tax guy saved us thousands by having us document all the improvements we'd made over the 10 years we owned it. We increased our basis by over $45k which significantly reduced our tax bill.