The sale of a second home may cost you some money if the IRS has anything to do with it. There may be a tax on the sale of the second home. Therefore, it is important to ask yourself, “What are the tax consequences of selling a second home?”
Federal tax law imposes a capital gains tax whenever you sell an asset, such as your second home, and earn a profit. Since the IRS only allows you to exclude the capital gain on the sale of your main home, avoiding or reducing your tax liability on the second home depends on the capital losses you have available, your tax basis in the home and the holding period.
If you have recently sold a second home that is not your primary place of residence, you will be required to report this transaction on Schedule D of your annual tax return.
Read More: Form 1040: What You Need to Know
Taxes on Selling a Second House
The IRS requires you to report all capital asset sales, except for the sale of your main home in some cases, on a Schedule D attachment to your return. This obligates you to calculate the amount of gain you recognize on the sale using your tax basis. So, you need to learn the sale of second home tax treatment to apply.
Generally, your tax basis in a second home is equal to the price you pay to acquire or construct it, inclusive of most closing costs, plus the cost of all home improvements you make. Once you determine your tax basis, you calculate the capital gains on the sale of a second home as the sale proceeds minus your tax basis.
Currently, you will pay zero percent if your income is less than $80,000. The 15 percent tax rate applies if you are single and earn up to $441,450, qualifying widow (er) or married and filing jointly and earn up to $496,600, married and filing as single and earn up to $248,300 and a head of household and earn up to $469,050. And if you earn anything over the maximum income threshold, the 20 percent capital gains tax rate applies for the extra income.
Defining the Holding Period
When you sell your second home at a gain, determining your holding period becomes extremely important. The holding period of capital assets refers to the length of time you own the property before selling it.
For a second home that you own for one year or less, you must report it as a short-term capital gain. And for all other properties you own for more than one year, classify it as a long-term gain. This one-year period applies to capital gains tax on real estate and on other investments like stocks and bonds.
The significance of these two holding periods is that your short-term gains are subject to the same ordinary income tax rates that apply to most of the other income you report on your tax return. However, the capital gains rates, which are generally lower than ordinary rates, apply to your long-term gains.
Capital Gains and Losses
The amount of tax you owe on the gain you report from the sale of your second home depends on the other capital assets you sell at a loss. This is because the IRS allows you to net your capital gains and losses together to reduce the amount of capital gains tax you will owe.
Moreover, you can use the remaining capital loss balances from prior years as well as the loss on sale of the second home in the current year to reduce your capital gain on the second home.
In the unfortunate event you must sell your second home for less than your tax basis, you can at least use the loss to offset other current and future capital gains you generate.
However, the IRS also allows you to claim a maximum annual capital loss deduction of $3,000 from your ordinary income (only $1,500 if you're married filing separately), but only if the second home is an investment property that you don’t use for personal purposes.
Your second home qualifies as an investment if you purchase it to generate rental income or to recognize appreciation in its value. However, if you ever use it for personal purposes, such as for vacations, the annual deduction is not available.
Recapturing Previous Depreciation Deductions
Throughout your ownership of the property, you may have taken depreciation deductions, which allow a property owner to spread out the cost of the asset over time.
If you later sell that property and realize a gain, you may have to recapture those deductions, i.e., the basis for the property is reduced by the depreciation. When that happens, the gain increases, resulting in a higher tax.
Recaptured depreciation gains are taxed at 25 percent, while long-term gains are taxed at a maximum of only 20 percent with many taxpayers paying a lower rate, so recaptured depreciation can increase your tax bill.
- Corporate Finance Institute: Capital Gains Tax
- HomeLight: Will I Pay Capital Gains on the Sale of My Second Home?
- IRS.Gov: Topic No. 409 Capital Gains and Losses
- Nasdaq: Long-Term Capital Gains vs. Short-Term Capital Gains (and Taxes)
- Nolo: How to Claim a Tax Deduction for Stock Losses
- MasterClass: Depreciation Recapture Guide: What Is Depreciation Recapture?
Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.