Recently, we have had a lot of clients purchasing a second home, to use as a vacation home or rental property. We have also had a handful of clients that are selling a second home that was they used as a rental property. There is a common question that arises in these situations – if I make a profit, will I owe taxes? Generally, if your second home was your primary residence for two out of the last five years, the ⅖ year rule, you can avoid part of the capital gains taxes. For joint filers, you can avoid up to $500,000 of profit, and for single filers up to $250,000 on the sale.
The percentage of capital gains tax that you would pay is based on the amount of time between January 1, 2009 and the date on which the home first became your primary residence.
For example, if you bought a second home on January 1, 2007 and made it your primary residence January of 2015 for two years and then sold it January 2018, 33.3% of your profit on the residence would be tax-free, up to the $500,000 primary residence sale exclusion limit.
Another common question that is asked, “Can I split the time between both residences, sell them and claim them both as my primary residence?” Clever, but unfortunately the answer is no!
Another option, is a 1031 exchange. If you treated your second home as an investment property, you could potentially escape capital gains tax through a 1031 exchange. However, there is a little catch to this, you must reinvest in a relatively short amount of time. With a 1031 exchange, you place your funds with a third party, such as a bank or title company and then reinvest in another property within 15 days of the sale of the first property and close on its purchase within six months (second home and capital tax).
You can usually sell your primary home without worrying about taxes, but different rules apply to vacation homes and rental properties.
We hope you find this article helpful!