The only thing better than owning a home of your own is owning two homes! It’s a sound financial investment, whether your second home is a vacation home, a rental, or even just a fixer-upper that you’re going to turn over for a profit. However, circumstances often make it necessary for homeowners to sell their second home. Maybe you’re too far away to enjoy the place, or you just don’t have the inclination to maintain the home. Whatever your reason may be for wanting to liquidate your equity in your second home, it brings to mind a very pertinent question. “Do I pay tax when I sell my second home?” Let’s do a deep dive to keep you abreast with all that you need to know.

Do I pay tax when I sell my second home?

Yes, and here’s why

property tax

The short answer to the question is yes, you do have to pay taxes on the profits you make from selling your second home. 

When a homeowner sells a primary residence, there isn’t much to worry about in terms of taxes on the profits from the sale. The IRS stipulates that up to $250,000 in profits from the sale of a home owned by a single person is not taxable. For a married couple, that number is $500,000 of gain on the sale.

However, you are liable to be taxed up to 20% of the profits you make from the sale of your secondary home, depending on the tax bracket that you fall into. This means that if you bought the property for $350,000 and sold it for $500,000, you make a profit of $150,000 from the sale. You would be liable to pay a tax of $30,000, or 20% of your profit from the sale.

Your second home, or non-primary residence, is looked at as an investment asset, irrespective of whether it is a holiday home or a rental property. Therefore, any profit you make from the sale of such a property is considered income and is taxed as such. While you could deduct depreciation from an investment property on an annual basis, you cannot do that if the home is used only for personal purposes.

These taxes that you pay on the profits from the sale of your home are called capital gain taxes.

Capital gain taxes explained

The IRS categorizes capital gains tax into two.

Long term capital gains tax

This is the tax you would pay if you’ve owned the property you’re selling for more than a year. Long-term capital gain tax rates are fixed at between 0 to 20% of the profit from the sale, depending on your earnings.

If your taxable income is between $78,750 and $434,550 and if you’re a single person, you will be charged a capital gains tax of 15% flat. That threshold amount is increased to $488, 850 for a qualified widow or widower and for a married couple filing jointly. However, the limit for a married couple filing separately would not qualify for the exclusion and would be charged 15% for a taxable income of $$244,455. The same tax rate applies to a head of household earning less than $461,700.

However, a flat tax rate of 20% will be charged if your taxable income is higher than the above-mentioned thresholds.

Short term capital gains tax

Short-term capital gains are the taxes charged if you’ve owned your second home for less than a year when you sell it. This is treated as an ordinary income, and you will be charged the same tax rate as you would be for your regular earnings.

Can you reduce your capital tax gains?

down payment

It’s understandable if you feel 15% to 20% of your profit margin from the sale of your second home is a lot to pay in capital gain taxes. It is, after all, your hard-earned money that you invested in the property. However, real estate experts do say there are ways you could reduce how much you pay in capital gains. We’re going to list a few of these ideas for your perusal. 

Show acquisition costs and property improvements

Your profit from the sale of your second home is calculated by deducting the cost you incurred while buying the property, or your cost basis, from the actual sale price. 

So if you bought a property for $300,000 and sold it for $400,000, your profit is $100,000.

However, your cost basis should also include any acquisition costs and capital improvement costs in addition to the purchase price. This means that if you spent an additional $20,000 on acquisition costs and an additional $50,000 renovating your home, your cost basis is actually $370,000. You could add any real estate agent fees you incur in the process of selling your home to further bolster your cost basis. This will greatly reduce your profit from the sale, as well as your capital tax gains tax rate.

Depreciate rental property

If your second home was occupied by tenants or available for rent, you could show real estate depreciation for the number of days it was occupied or available for rent each year you owned it. The percentage of depreciation deduction from your cost basis would depend on the time period it was either available for rent or occupied.

However, depreciating your second home makes you liable to pay another tax known as depreciation recapture. This tax is a flat 25% of the cumulative depreciation you show.

1031 Exchange

This is a viable and popular option for those whose second home is purely investment property. You can sell your home and reinvest the entire money into another rental property.

This way, you can defer paying capital gains tax altogether. There are a few catches, however.

You cannot live in your second home, or use it as a vacation home. It must remain a rental. You are also compelled to find the property you intend to reinvest in within 45 days of your second home is sold, and close the purchase within 180 days. Should you fail to do so, you will be liable to pay the capital gains tax in its entirety.

In order for you to be eligible for a 1031 exchange, you need to have owned your second home for at least 24 months prior to selling it. You must be able to show that the property was rented out for a minimum of 14 days during that time period, and your personal usage of that property must not exceed 14 days a year.

This means that if you’ve rented your vacation home for more than 14 days a year and lived in it for less than 14 days a year, it technically qualifies for a 1031 exchange. 

Read more: Use HELOC to buy second home

Always consult experts

We hope this short idea has answered any questions you may have about paying taxes on the sale of your second home, and on saving on capital gains taxes. However, it is always advisable to consult with your accountant before you dive into these saving methods. Real estate tax laws can be murky waters for the uninitiated.

Read more: Vacant home insurance

Do I pay tax when I sell my second home? was last modified: October 3rd, 2022 by Narayan Shrouthy
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Great, I thought that what I should pay in taxes is much less … I generally like the blog readings, but today they have made me very unhappy …