• calendar_month October 12, 2022

Selling a Vacation Home: Understanding Capital Gains on the Sale of a Second Home

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In this article:

• Figure out your residential status
• Calculate what you might owe in capital gains taxes (if applicable)
• Minimize your tax obligations
• Defer capital gains taxes
• Decide when to sell
• Strategize the sale

Selling a second home can be just as complicated as selling your primary home, due to factors like the distance between where you live and the property you’re trying to sell and the logistics of scheduling around renters. But one of the biggest challenges people run into when thinking about selling a vacation or rental property is calculating the capital gains taxes you’ll be responsible for paying.

Before you make a plan to sell, you’ll need to understand the type of property you own and the potential taxes on selling a house, then use that information to be strategic about your listing, marketing and timing.

Zillow Group, Inc. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.

Defining property status

• Primary home: Your primary residence is the place you live the majority of the year (six or more months per year). It’s close to where you’re employed, and it’s where you’re documented — meaning it’s the address on your driver’s license and where your voter registration and bills are sent. 
• Vacation home or second home: This is a home that’s a reasonable distance from your primary residence. It’s exclusively yours (not a rental or a timeshare), it’s usually accessible by car, and you inhabit it for at least some period of time each year. According to Zillow research, 6 percent of homeowners say they are the sole owners of a vacation or second home. 
• Rental property: This is not your primary residence. It’s property you purchased to generate income, and at whatever point you do sell, you hope to make a significant return on your investment. This would include properties where you have long-term tenants, vacation properties you rent out and flips. According to Zillow research, 6 percent of homeowners say they own an investment property other than their primary residence.

Capital gains tax varies by residential status

As mentioned earlier, when selling a primary residence — the home the owner lives in on a day-to-day basis — many sellers are exempt from capital gains taxes. 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.

When it comes to second properties, capital gains tax liability can vary based on whether your home was a vacation property or a rental property.

Taxes on selling a second home

Unlike your primary home, which is typically exempt from capital gains taxes (with a few exceptions detailed later), the IRS considers a second home a “personal capital asset.” You must file a Schedule D with your Form 1040 on your taxes for the year you sell, reporting the sale of your second home. Here are a few more things you need to know:

• Selling a second home is similar to selling stock: You’ll be taxed on the profits of the sale in the same way you are when you sell other assets, like shares of stock. 
• If you own the home for more than a year, you’ll pay long-term capital gains taxes, and the tax rate depends on your income — more on that later. 
• If you own the property for less than a year, you’ll pay short-term capital gains taxes, and the rate is the same as your ordinary income-tax rate. For most taxpayers, it’s advantageous to wait at least a year after purchasing a second home before selling.

Taxes on selling a vacation property

If you’re selling a vacation home that you haven’t ever rented out, the taxation will be similar to that of a second home. The taxes will be calculated based on the sale price, less what you paid for the property (your tax basis). Just like a second home, the tax rate will be based on whether the property was held for more or less than a year. The IRS considers a vacation home a “personal capital asset.” 

Taxes on selling a rental house

Rental houses typically qualify for some deductions and write-offs, but it’s important to talk to your tax professional. Here are a few key differences between selling a rental property and a vacation home. 

• If you’ve been deducting depreciation on your rental property on your tax return every year to offset the tax you pay on rental income, it’s important to remember that those write-offs reduce your adjusted basis, increasing your taxable gain when it comes time to sell.
• Any suspended tax losses (i.e., when your rental income is lower than your total rental property deductions) that were disallowed due to income limitations are deductible in the year the property is sold, regardless of those income limitations in that year.
• If you previously lived in the home as a primary residence or second home prior to it becoming a rental property, your adjusted tax basis becomes significantly more complicated, and you should seek the advice of a tax professional to determine your gain basis and your loss basis.  
• If you’re planning on purchasing another rental property after selling your current property, you may be able to opt for a Section 1031 exchange. More on that shortly.

Calculating capital gains tax

Before you even consider selling a second home, figuring out what you might owe the IRS is a must.

What is the capital gains tax rate on real estate?

For the sale of a second home that you’ve owned for at least a year, the capital gains tax rates for 2019 are 0 percent, 15 percent or 20 percent, depending on your income in that year (including the gain on the sale of the property). According to the IRS, the majority of taxpayers fall into the 15 percent bracket.

If you’re filing under a different status, capital gains tax rates can be found here.

Figuring out what you owe in capital gains

Once you’ve figured out your capital gains tax rate using the table above, and assuming you’ve owned for at least a year, here’s how you can figure out what your tax liability might be on the sale of of a second home or rental property. Of course, you should always consult with a tax professional. 

After you have a good estimate of your tax liability, set that money aside or pay it ahead of time in an estimated tax payment to avoid surprises at tax time. When it’s time to do your federal taxes, you’ll need to report the sale and all the figures above on a Schedule D. The example above is provided for illustrative purposes, and there could be other costs, including state income taxes due, as well as real estate transfer taxes.

How to minimize the capital gains on a second home

There are a few strategies for selling your second home without as much money lost to capital gains taxes. 

1. Make your vacation home your primary residence: To be eligible for the $250,000/$500,000 exemption on the tax gain, you must have lived in a home for two out of the last five years before selling. Remember: You must be able to give proof of residency with items like a driver’s license, voter registration card or utility bills. 
2. Offset your capital gains with other losses: If you have other major deductions — say you lost money in the stock market the same year — those losses can offset your capital gains liability. 
3. Don’t sell at all: If you don’t have an urgent need to sell, consider holding on to the property and leaving it to your kids or another family member in your will. When someone receives property as an inheritance, the home’s fair market value at the time of inheritance becomes the new basis for calculating capital gains taxes, which can mean a much lower tax bill for them than what you’d encounter.

Deferring capital gains taxes with a 1031 exchange

Another option for deferring capital gains taxes is to do a tax-deferred exchange, called a Section 1031 exchange by the IRS. 

A 1031 exchange is a swap of one investment property (not a personal vacation home) for another, and it allows you to defer most or all of your capital gains liability. You’re basically changing the property you invest in, and the IRS doesn’t see it as cashing out, because the new investment property is viewed as substantially similar in type to the original property. However, 1031 exchanges can be complicated, so always talk to your lawyer and tax professional. 

In general, though, here are some requirements to keep in mind:

1. Tax-deferred exchanges are only available on rental properties, not primary homes or vacation properties. 
2. The property you are selling (called the relinquished property) and the property you are buying (called the replacement property) must be considered “like-kind” (similar in type). 
3. You’ll need a qualified intermediary. The intermediary holds the cash from your first sale and applies it to your new purchase on your behalf, so you’re never actually cashing out on the sale. 
4. There are time limits you need to follow to avoid the swap being taxable. First, you have to identify replacement properties in writing to your intermediary within 45 days of selling your relinquished property. Second, you have to complete the sale of the new property within 180 days or before your income-tax return is due for the year that you sold the original property. 
5. You may still be subject to some taxes. Let’s say your replacement property is a bit cheaper than your relinquished property. You’ll likely be liable for capital gains taxes on the difference. 
6. After the 1031 is complete, you can’t immediately turn the rental property into a vacation home. You have to use it as a rental for at least six months to a year first. 
7. If you do eventually turn the home back into your primary residence, you’ll have to live there for five years before selling if you want to avoid capital gains taxes.
8. You can do 1031 exchanges as many times as you want.

When to sell an investment property or vacation home

Once you understand the capital gains taxes on a second home, it’s time to decide on a listing timeline.

Timing is everything when selling a second property

Whether you’re selling a primary residence, an investment property or a vacation home, timing is crucial. When dealing with a second home, sellers sometimes have a bit more flexibility with timing. Here are a few ways to know if it’s a good time to sell. 

• Keep your market in mind: If you’re selling a ski house in Colorado, it may sell better in winter, when tourists are already in town. But a beach house in Michigan may sell better in the summer. 
• Think of seasonality: All major metropolitan areas have a best time of year to sell — it’s the time of year when your home is likely to sell more quickly and for more money. Nationally, the best time of year to sell is the first half of May. Homes listed during this window sold six days faster than average and for $1,600 more, compared to average points in the year. There is some variation city by city, so check out the hottest time to sell in your area. 
• Consider your whole timeline: Once you decide to sell, you won’t be ready to list your home the next day. Make sure to factor prep time into your timeline. For example, if you want to list your home in time for the peak spring season, you may want to start prepping right after the holidays. 
• Don’t forget the rental possibility: Not a great time to sell? If you’re able, consider renting the property temporarily until market conditions are more favorable.

When to sell a rental property

If you rent your second property, either as a vacation rental or to long-term tenants, there are a few more considerations. You’ll need to work around your tenants’ schedule and the terms of their reservation or lease. And if you anticipate any repair work needing to be done before listing, make sure to follow state laws about how much notice you need to give a tenant before entering their property. 

Steps to sell vacation homes

1. If your property is a timeshare, condo or part of a homeowners association, make sure there are no rules about when you’re allowed to list and when you’re allowed to make repairs. 
2. Clean up and declutter, getting rid of unused items that might make the home feel small or outdated. 
3. Complete any necessary repairs. 
4. Make any upgrades to bring the property up to date — new appliances, for example. 
5. Find a real estate agent who specializes in vacation home sales and your particular market. 
6. Use comparables from your area to identify an appropriate price. This can be especially tricky in a vacation rental market, but your real estate agent should be able to guide you through the process.  
7. Write a compelling listing description. If you’re using an agent, they’ll likely complete this for you. 
8. Have professional real estate photos taken. This is especially important for vacation homes, as potential buyers may live in a different city, so they’re more likely to rely on online searching. 
9. Consider having your home staged so it will be more welcoming for potential buyers. This can be especially helpful in a competitive market.