10/15/2025
Reposted from the BRIGANTINE TIMES Excellent column by Marie LePera "From Under the Hat"
Selling a second home can come with an unexpected tax burden and it doesn't matter if it's a vacation/seasonal house or even a rental investment, the IRS treats the sale of these properties as a taxable event. But with the right planning, you can reduce, defer, or even avoid capital gains taxes when selling a second property. In looking at the three best strategies for doing so - from a 1031 exchange (will explain later in the column) to converting your vacation home into your primary residence, here's what to know: Just what is capital gains tax on a second home? When you sell a capital asset it's the difference between what you bought it for and what you sell it for is a capital gain (if you make money) or loss (if you lose money). The IRS levies a special tax rate on capital gains, ranging from 0% to 20%, or higher in some unique instances. Tax Payer Relief Act of 1997.
Luckily, if you are selling a primary residence, you get a special exception and exclude up to $250,000 of capital gains from taxes if you filed as a single taxpayer. If you're married and file jointly this goes up to $500,000. And there are generous terms for deducting the cost of any home improvements to lower the tax, so keep all those receipts from Home Depot! If your home isn’t your primary residence, like so many of our seasonal owners it's a vacation home, a rental property, or investment property be prepared to pay capital gains tax when you sell. How much you pay will depend on several factors.
Capital gains taxes are levied only on the net gain you make from your sale. For example, if you bought your second home for $300,000 and sold it for $500,000, you’d net $200,000 on the sale—and only that amount (not the full $500,000 sale price) would be subject to capital gains tax. But the rate at which your gains are taxed depends on two factors: your income and how long you’ve owned the house. If you’ve owned a property for one year or less before you sell it, it’s considered a short-term capital asset and is taxed according to your ordinary income tax bracket. If you’ve owned an asset for a year or longer before selling it, you’ll be taxed at a long-term capital gains rate, which is typically lower than your income tax rate. These rates vary based on your income, ranging from 0% to 20%. In order to reduce your capital gains, it requires planning. Three of the most common ways to avoid it are 1) using a 1031 exchange. Investment property owners defer paying capital gains taxes by reinvesting the proceeds from a property sale into a new investment property. This allows investors to preserve their capital and grow their portfolio without an immediate tax burden. It's a great way to delay taxes and eventually avoid them all together if the replacement property is held long enough. An example, say you purchased an investment property for $750,000 and later sold it for $1 million you’d typically owe capital gains on the $250,000 profit. However, if you use a 1031 exchange, you could reinvest your gain to purchase a new investment property and postpone your tax liability. A 1031 exchange comes with strict requirements. They can only be used for investment properties, not personal residences. However, if you first turn your second home into a business property by renting it out before selling, you may be able to qualify for a 1031 exchange. The 1031 Corp is a good resource to research.
2) You could also turn your second home into a rental property. If your second home is in a coveted vacation spot, for example in Brigantine, consider turning it into a short-term rental. This business can net you enough to cover operating expenses and then some. This is where the LePera Team is on hand! If you don’t want to deal with short-term rentals, long term yearly rentals are also a solid option, especially with the scarcity of them on our island. In Brigantine, the city requires a rental inspection before a tenant takes occupancy, so be ready to fix a broken screen or patch a nail hole before and when your tenant moves.
3) Make your second home your primary residence. If you’ve lived in your home for at least two of the past five years, it may qualify as your primary residence, making you eligible for a significant capital gains tax exclusion when you sell. This can be a smart tax strategy if you’re considering selling a second home in the next few years. Moving in now could help you take advantage of this benefit especially if you seek warmer climates in the winter months. However, if you’re married and filing jointly, both spouses must meet the residency requirement, even if only one spouse owns the property. This exclusion also has a limit: You're not eligible if you've already claimed it in the past two years. Your accountant can assist you with the process and a I can get the form from our title agent showing you the required paperwork that you would sign at closing. This strategy might not be foolproof, especially if you have a significant amount of equity in the home.
As people have stayed in their homes longer, even sellers of primary residences are increasingly getting hit with a 'hidden home equity tax' in the form of an unexpected capital gains tax bill. And that's because the exclusion limits haven't been adjusted for inflation since 1997. If they had, they'd be closer to $500,000 for individuals and $1 million for married couples.
Those in the know say that one in three homeowners have more equity in their primary residence than the exclusion for single. By 2030, that number is expected to skyrocket to more than half of homeowners. So, before moving into your second home and making it your primary residence, make sure any projected profits would be comfortably below the current exclusion limits of $250,000 for individuals and $500,000 for married couples. Because if they aren't, you may end up paying a capital gains tax anyway. If we, the LePera Team, can guide you to the right professionals, just let us know.
