Selling a Furnished Vacation Home: Allocating Between Real & Personal Property – Houston Tax Attorneys

A vacation home is nice to have. Many vacation homes are owned for years–if not decades. The capital gains tax can be substantial when the owner goes to sell the property. And unlike a primary residence, the $250,000 or $500,000 gain exclusion under Section 121 is not available for a property that was never the owner’s principal residence. So every dollar of gain can be taxable.

One way to reduce the gain is to allocate part of the sale procees to the furnishings inside the property. The idea is that when a furnished property sells for a single lump-sum price, not every dollar of that price necessarily represents the value of the real estate. Some portion may reflect what the new buyer paid for the furniture, appliances, and décor that come with it. If the owner allocates part of the sale price to those items, the amount realized on the real estate drops—and so does the taxable gain.

What makes this work is that furnishings typically sell for far less than what the owner originally paid for them. Used furniture depreciates quickly. A sofa that cost $3,000 in 1994 is not worth $3,000 in 2015. So when a portion of the sale price is allocated to furnishings, the owner will almost always show a tax loss on the personal property side of the transaction. That loss does not increase the real estate gain, and importantly, it does not get added back in. The loss is simply nondeductible because the items were held for personal use. The net effect is that the owner has shifted dollars away from taxable real estate gain and into a loss that costs nothing in tax.

That is the theory. Whether it works in practice depends entirely on whether the owner can prove it. The recent decision in Gyarmati v. Commissioner, T.C. Memo. (filed March 26, 2026) provides an opportunity to consider this in practice. We can also use the same fact pattern to show how this allocation issue does not work for vacation properties that are held as short term rental properties.

Facts & Procedural History

The taxpayer owned and operated several car dealerships. He is also a licensed interior designer. In February 1989, he and his wife purchased an unfurnished condominium in Marco Island, Florida for $410,000. The approximately 3,000-square-foot property served as a family vacation home. The taxpayer bought furniture for the conduct throughout the years.

In 1992, Hurricane Andrew severely damaged the condo. Windows failed, water flooded the interior, and mold spread through the unit during the days without power or air conditioning. The taxpayer’s insurance excluded mold damage. He funded remediation himself and replaced much of the furnishings, flooring, wall coverings, and drywall. The family continued to use the condo as a vacation home—though infrequently. The taxpayer sold the condo for $775,000 in 2015.

The taxpayer did not file federal income tax returns for 2014 or 2015. Because no return was filed for 2015, the IRS prepared a Substitute for Return (“SFR”) under section 6020(b) of the tax code and issued a Notice of Deficiency. The notice determined a deficiency of over $800,000 for 2015.

The taxpayer petitioned the U.S. Tax Court. After various concessions, the dispute narrowed to the sale of the Florida condo. The dispute invovled whether the adjusted basis should be increased by $95,000 for capital improvements beyond the $18,574 the parties had already agreed upon and whether $62,500 of the $775,000 sale price should be allocated to furnishings sold with the condo, which would reduce the gain attributable to the real estate itself.

How Capital Gain Is Calculated

To understand what was at stake in this case, we have to start with how capital gain is computed.

The formula is simple: the amount realized on the sale minus the taxpayer’s adjusted basis equals the gain. The gain is then multiplied by the applicable tax rate to arrive at the tax due. That is the whole equation. The dispute in this case was entirely about the two inputs on the left side of that formula—the amount realized and the adjusted basis—and whether either one could be reduced.

What Goes Into the Amount Realized

The amount realized is generally the total sale price, reduced by selling costs such as commissions and closing fees. In a straightforward sale of real estate, the amount realized is easy to determine. When a furnished property sells for a single lump-sum price, however, the question becomes whether the entire purchase price represents the value of the real estate—or whether some portion of it reflects what the buyer paid for the furnishings inside. That allocation question is the dispute in this case, so we’ll address it further below.

What Goes Into the Adjusted Basis

The adjusted basis is essentially the total of what the taxpayer has invested in the asset. A higher basis means less taxable gain. A lower basis means more. The starting point for basis is the original purchase price and certain closing costs under Section 1012 of the tax code. From there, section 1016(a) provides that the taxpayer increases basis by the cost of capital improvements made after purchase. These are expenditures that add to the property’s value, extend its useful life, or adapt it to a new use—betterment, adaptation, and restoration are the terms the tax code uses.

Routine repairs and maintenance are treated differently. Those costs do not increase basis. For a rental property, repairs are deducted in the year the cost is incurred. For a personal-use vacation home, they are simply nondeductible personal expenses. The same is true for capital improvements to a personal-use property — they increase basis, but they cannot be deducted along the way. The owner gets the benefit only at the point of sale, when a higher basis reduces the taxable gain. That is why tracking improvement costs over a long holding period matters so much, and why the records supporting those costs have to survive the entire ownership period intact.

The distinction between a capital improvement and a repair is sometimes obvious and sometimes genuinely difficult to draw. Replacing a roof is an improvement. Patching a leak is a repair. When hurricane damage destroys windows, floors, and interior walls and the owner replaces everything, the work may qualify as capital improvements rather than repairs—depending on the scope and permanence of the restoration. Good real estate tax planning accounts for this distinction from the start, because over a long holding period the difference in basis can translate into a very large difference in tax at the point of sale.

How to Allocate Sale Proceeds to Personal Property

With this understanding of tax basis, we can turn to the allocation issue. This case involved the sale of a furnished condo. One has to allocate the amount realized or sales price between the items sold when personal property—furniture, appliances, artwork, or fixtures—are conveyed along with real estate in a single transaction.

The taxpayer has to establish two things for this. First, the personal property has to actually have been part of the transaction—meaning the buyer paid something for it, whether or not the parties acknowledged it explicitly. Second, the taxpayer needs evidence of the fair market value for both the real property and the personal property to support the allocation.

The tax court noted that it had previously addressed this squarely in Peterson v. Commissioner, T.C. Memo. 1987-508, where it refused to allocate proceeds between a house and its furnishings given the complete absence of supporting evidence. That case established a clear expectation: if a taxpayer wants to reduce a capital gain of the real estate by allocating proceeds to personal property, they need a sale agreement that explicitly assigns value to the furnishings, an independent appraisal of the furnishings, or at minimum some reliable evidence of what the items were worth at the time of sale.

The reason this allocation matters is straightforward. The entire $775,000 sale price was initially treated as proceeds from the sale of real estate, which produced a large capital gain. By arguing that $62,500 of that price was actually paid for the furnishings rather than the real property, the taxpayer reduces the amount realized on the real estate by that same $62,500—and his capital gain on the real estate shrinks accordingly.

As for the furnishings themselves, the taxpayer’s basis in them equals what he originally paid, since he never depreciated them. The property was purely personal use and not a short term rental property, so no depreciation was ever available on either the real estate or the furnishings. With furnishings that were decades old, the fair market value at the time of sale was almost certainly far below his original cost—meaning he would have recognized a loss on the personal property side of the transaction. That loss, however, would be nondeductible because the furnishings were held for personal use. So the actual tax benefit of the allocation flows entirely from the reduction in real estate gain, not from any deductible loss on the furniture.

The Taxpayer’s Arguments Didn’t Hold Water

This brings us back to the actual facts in this case. The taxpayer here advanced two arguments to reduce his $289,419 gain on the sale of the condo. The first was that his adjusted basis should be increased by $95,000 for capital improvements made after Hurricane Andrew—separate, he claimed, from hurricane-related repairs and separate from the $18,574 in improvements already conceded by the parties. The second was that $62,500 of the $775,000 sale price should be allocated to furnishings sold with the condo.

On the capital improvements issue, the taxpayer testified that he spent “probably $150,000” remodeling the condo. He produced a handful of documents to support that claim: a sales order for a metal wall bracket, a floor tile selection sheet, order forms for two bathroom light fixtures, and a 1994 order form for a $23,000 chandelier. Every single item was either purchased in Michigan or shipped to his home in Bloomfield Hills. His position was that dealership panel trucks transported these items to Florida, where they were installed in the condo.

The tax court noted that it found the taxpayer to be not a credible witness. It concluded that his testimony was vague and often inconsistent. He struggled to recall when the remodeling projects occurred and provided little description of what work was actually performed. As courts have long recognized in situations like this. With this finding and no credible testimony and no documents connecting these purchases to the condo, the court concluded was no reasonable basis upon which to estimate additional improvements.

On the furnishings allocation, the problems were similar according to the court. The taxpayer produced furniture invoices dating from 1984 to 1994. Many of the invoices predated Hurricane Andrew, leaving open the question of whether the furniture even survived the storm. The invoices listed the taxpayer’s Michigan home as the delivery address. The items invoiced, in total, described more furniture sets than could physically have fit in the condo. At the time of sale, any furnishings reflected in those invoices would have been between 21 and 31 years old. The court found it unlikely that a buyer would assign meaningful value to furnishings of that age.

More fundamentally, the taxpayer admitted he had no sales contract and no separate bill of sale for the furnishings. He admitted he did not know the fair market value of the condo itself or of the furniture. Without any valuation evidence for either component of the transaction, the court held there was no reasonable basis upon which to allocate any portion of the proceeds to furnishings. The entire $775,000—reduced by $57,007 in conceded transaction costs—was treated as the amount realized on the real estate.

Application for Short-Term Rental Owners

The facts in this case are somewhat rare these days. Many, if not most, vacation homes are actually held as short-term rentals, given the rise of platforms like Airbnb and VRBO. That distinction matters here, because the allocation strategy at the center of Gyarmati works only when the furnishings have not been depreciated. For a short-term rental owner, that condition is unlikely to be met—and that changes the analysis entirely.

When a property is held as a rental, the furnishings inside it are depreciable assets. Under Section 1016(a)(2), basis is reduced by the amount of depreciation that was “allowed or allowable”—meaning the reduction happens whether or not the owner actually claimed the deduction. A short-term rental owner who never bothered to depreciate the FFE does not preserve basis. The basis comes down regardless, and the owner simply forfeits the deduction in the process.

That reduced basis creates a very different outcome at the point of sale. When a short-term rental owner allocates part of the sale proceeds to furnishings, any amount realized on those items in excess of their adjusted basis triggers depreciation recapture under Section 1245, taxed at ordinary income rates. So unlike the personal-use scenario in Gyarmati—where shifting dollars to the furnishings produced a nondeductible loss that cost nothing in tax—shifting dollars to the furnishings in a rental context can actually produce additional taxable income. The allocation strategy that works for a purely personal vacation home can backfire for a rental property owner.

The better planning tool for short-term rental owners is bonus depreciation under Section 168(k). Enacted in its current form by the Tax Cuts and Jobs Act of 2017, bonus depreciation allows a taxpayer to deduct the full cost of qualifying FFE in the year it is placed in service rather than recovering it over the 5-year or 7-year MACRS class life that would otherwise apply. The 100% rate applied through 2022, with a scheduled phase-down thereafter: 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026. Under current law the provision expires entirely for property placed in service after 2026, though Congress has revisited these rules before. Section 179 of the tax code provides a related avenue, allowing an immediate expense election up to an annual inflation-adjusted cap, though unlike bonus depreciation it cannot produce a tax loss.

When FFE is fully expensed through bonus depreciation in the year of purchase, the adjusted basis in those assets drops to zero immediately. There is nothing left to track, reconstruct, or defend at the point of sale. And from a records retention standpoint, the obligation is equally clean. The IRS generally has three years from the filing date to assess additional tax under Section 6501, extended to six years when income has been understated by more than 25%. A short-term rental owner who claims bonus depreciation on furnishings in year one needs to retain those purchase records only through the audit window for that return—not through the 5-year class life, not the 7-year class life, and not the multi-decade holding period that the taxpayer in this case could not reconstruct at trial.

The Takeaway

This case shows that documentation is everything when it comes to tax basis and the allocation of gain between asset types. For those selling real estate, they need to have documentation to support their tax positions. The IRS and tax court will be looking to the taxpayer for logical and clear explanations and also documentation. The amounts at issue can be significant, as shown by this case. What is missing from this case is not just documentation. It is the absence of outside experts. This is an area where hiring outside advisors to help determine or recreate records when records are missing and to determine how to make the allocations can be helpful. This can include valuation experts, cost segregation study providers, and/or CPAs and tax attorneys. These professionals have ways of recreating basis and making allocations that the courts are more likely to accept. This can make the difference between a defensible tax position and an unwinnable argument.