Selling a Vacation Home
A second home sale can be as difficult as selling your primary residence. This is due to factors such as distance from where you live to the property being sold and logistics surrounding scheduling around renters. However, the biggest problem people face when selling their vacation property or rental property is how to calculate the capital gains taxes they will have to pay.
Before you decide to list your property, it is important to know what type of property you have and what taxes might be associated with selling your house.
Determining Your Property Status
Primary Residence:
This is where you live for six or more months each year. It is close to your job, and it is where you are documented. This address also serves as your driver's license and the address where your bills and voter registrations are sent.
Second-Home Or Vacation Home:
A home located at a reasonable distance away from your primary residence. You are the sole owner of it (not renting or using timeshare), you can usually access it by car, and you live there for at least part of the year. Research online shows that 6 percent of homeowners claim to be the sole owners of a vacation home or second home.
You Are Renting Property:
It is not your primary residence. This is a property that you bought to generate income. At any point, you will see a substantial return on your investment. These properties could include rentals, flips, and properties that you have long-term tenants. Research online shows that 6 percent of homeowners have an investment property in addition to their primary residence.
Capital Gains Tax Is Dependent On Your Residential Status
Many sellers are exempted from capital gains taxes when they sell their primary residence. This is the place where the owner lives on a daily basis. This assumes sellers have made this their primary residence for a minimum of two out of the past five years, and their gain (or profit) on the home is less than $250,000 for single filers or $500,000 for married-filing-jointly filers.
Capital gains tax liability for second properties can differ depending on whether the property was a vacation home or a rental.
Selling A Second House? Taxes
The IRS does not consider your primary residence exemption from capital gains tax. However, there are a few exceptions that may be discussed later. These are just a few of the things you should know.
Selling a second house is like selling stock. You will be taxed on the proceeds in the same manner as you would when you sell stock or other assets.
If the property is owned for longer than one year, you will be subject to long-term capital gains tax. The tax rate depends on your income.
You'll be subject to short-term capital gains tax if you have the property for less than a year. The rate is the same rate as your normal income-tax rate. It's a good idea to wait at most one year before selling a second home.
Selling A Vacation Home Attracts Taxes
Taxation for a vacation property that you have never rented out will be the same as for a second residence. Your tax basis is the amount you paid for the property less the sale price. The tax rate for a second residence will be the same as for a home. It will depend on how long the property has been owned. An IRS definition of a vacation home is a "personal capital asset."
Taxes For The Sale Of A Rental Property
Most rental houses are eligible for certain deductions and write-offs. However, it is important to speak to your tax professional. These are the key differences between renting a rental property or selling a vacation home.
You should remember that if you have been writing off depreciation for your rental property every year in order to offset the tax you pay on rental income, it will reduce your adjusted basis and increase your taxable gain when you sell it.
All suspended tax losses (i.e., when your rental income falls below your total deductions for rental property) are deductible in the year that the property is sold regardless of income limitations.
Your adjusted tax basis would be significantly different if you lived in the property as a primary residence, second home, or rental property. You should consult a tax professional to determine both your gain basis and loss basis.
You may be eligible for a Section 1031 exchange if you are looking to purchase another rental property after you have sold your current one. We'll be discussing this shortly.
Calculating Capital Gains Tax
It is essential to determine what taxes you may owe before you consider selling your second home.
What Is The Capital Gains Rate For Real Estate?
The capital gains tax rates are for the sale or transfer of a second residence that you have owned for at least one year. They vary depending on your income and the gain from the sale. According to IRS, most taxpayers fall within the 15% bracket.
Calculating Your Capital Gains Owes
After you have calculated your capital gains tax rate by using the table below and assumed you own the property for at least one year, here are some ways you can determine your tax liability if you sell your second home or rental property. You should consult a tax professional.
Once you have an accurate estimate of your tax liabilities, either set it aside or make an estimated tax payment in advance to avoid any surprises. You will need to file your federal taxes.
How To Reduce Capital Gains From A Second House
There are several strategies to sell your second home without losing capital gains tax.
Make Your Vacation House Your Primary Residence:
You will be eligible to receive the $250,000/$500,000 tax gain exemption. Keep in mind that you must be able to show proof of residencies, such as a driver's license or utility bills.
You Can Offset Capital Gains With Other Losses
Do Not Sell:
If there is no immediate need to sell, you might consider keeping the property and transferring it to your children or other family members in your will. If someone inherits property, their fair market value at the time becomes the basis for capital gains tax calculations. This can result in a lower tax bill than you would encounter.
A 1031 Exchange Allows You To Defer Capital Gains Taxes
A tax-deferred trade, also known as a Section 1031 exchange (IRS), is another option to defer capital gains taxes.
You can defer all or most of your capital gains liability by using a 1031 exchange. The IRS does not consider it is cashing out because you are changing the type of the investment property. But 1031 exchanges are complicated. So always consult your tax professional and lawyer.
These Are The Main Requirements You Need To Remember:
Only rental properties are eligible for tax-deferred exchanges.
You must consider the property you are selling (called relinquished property) and the property you are purchasing (called replacement property).
A qualified intermediary is required. An intermediary is someone who holds cash from your first sale. They then apply it to your next purchase. This ensures that you are never cashing out.
To avoid your swap becoming taxable, there are certain time limitations you must follow. Your intermediary must be notified within 45 days after you sell your relinquished property. You must also sell the property within 180 days of selling the original property.
Some taxes may still apply to you. Let's suppose your replacement property is slightly less expensive than the relinquished one. Capital gains taxes will likely apply to the difference.
You can't turn your rental property into a vacation house immediately after 1031 has been completed. It must be used as a rental property for six months to one year.
To avoid capital gains tax, you will need to live in the home for five years if you decide to make it your primary residence.
You can exchange 1031 times as many as you like.
How To Sell A Vacation Home Or Investment Property
Once you understand the capital gains tax on a second residence, it is time to determine a listing timeline.
Selling A Second Property Is All About Timing
Timing is key, whether you are selling a primary residence or an investment property. However, sellers sometimes have more flexibility when it comes to timing when selling a second house. These are some ways to determine if it is a good time for you to sell.
Be Aware Of Your Market:
If you are selling a Colorado ski house, consider winter when more tourists will be in town. A beach house in Michigan might sell better in summer.
Seasonality Is A Concept That Can Be Used To Describe Seasonality:
Major metropolitan areas all have the best season to sell. It's when your home will sell faster and for more money. The first half of May is the best month to sell a home. This window saw homes sell six days earlier than the average and at $1,600 less than average. There are variations from one city to the next, so make sure you check out the most popular time to sell.
Take A Look At Your Entire Timeline:
If you decide to sell your house, you won't have the time to list it immediately. Be sure to include prep time in your timeline. If you are looking to sell your home before the peak spring season, it is a good idea to get started prepping immediately after the holidays.
Do Not Forget About The Rental Option:
It's not a good time to sell. You might consider renting the property temporarily while you wait for market conditions to improve.
How To Sell A Rental Home
There are some additional considerations when renting your second property as a vacation rental or long-term tenant. It is important to accommodate your tenants' schedules and the terms of the lease or reservation. If you expect any repairs to be required before listing, you should follow the state laws regarding how much notice you must give tenants before you enter their property.
How to Sell Vacation Homes:
You should check that there are no restrictions on when your property can be listed and when repairs can be made if it is a condo, timeshare, or condominium.
Get rid of any unused items that could make your home feel small or old.
Make any necessary repairs.
Upgrades to the property are recommended, such as new appliances.
Locate a vacation home agent that specializes in your market and vacation home sales.
Find comparables in your area to determine a fair price. This can be particularly difficult in a vacation rental market. Your real estate agent should be capable of guiding you through the process.
Create a compelling description. An agent will likely complete this if you are using them.
Professional real estate photos are taken. This is particularly important for vacation homes as potential buyers might live in another city. Therefore, they are more likely to use online search.
Consider staging your home to make it more inviting for potential buyers. This is especially useful in a highly competitive market.
