Why consider selling your second home?
We are living in stressful times. Therefore, a getaway from the daily routine is essential to good health and to refocusing to remain productive. However, when most people think of a second home, they fixate on desired vacation destinations. For example, if you live and work in Ocala, your dream may be to own a Panhandle beach side escape or a Smoky Mountain cabin retreat. After enjoying your dream second home for a while, your thoughts may begin to drift back towards practicality. You may begin to realize that the farther away this home is, the less it impacts your lifestyle. Therefore, you may decide to replace it with a home you can escape to on weekends.
If retirement is on the horizon, you may be reassessing your lifestyle priorities and looking to downsize. You may wish to replace your retreat with one in an active adult community. Therefore, you may redirect your planning towards filling what was your busy work schedule with activities you love. Mind stimulating learning experiences, physical fitness regimes and opportunities to socialize may become your focus.
If you anticipate that the current recession will put your finances under stress, you may wish to consolidation. Therefore, you may conclude that to survive the turmoil you should consider selling your vacation escape.
The reasons to sell are varied. However, as you plan to move forward, you would be wise to factor in economic and tax considerations.
Selling your second home – economic considerations:
Currently, the inventory of homes for sale is very low. However, demand has also been negatively impacted by fear and the astronomical rise in unemployment. To understand how these factors and many others impact your plan to sell, you need to comprehend their effect on your market. Therefore, you should seek advise from a Realtor in the market where your second home is located. You would be wise to educate yourself in order to be able to make sound choices as to the sale of your property. However, one element to certainly consider is that a driving force in today’s market is the lowest cost of borrowing on record. Low mortgage rates encourage buyers to enter the market and make it easier for them to qualify for loans. Therefore, they enhance your ability to sell.
Selling your second home – tax considerations:
Generally speaking, the gain on the sale of your second home is subject to taxation. This gain is computed by subtracting the net cost of acquisition from the net proceeds of sale.
The net acquisition costs formula is as follows:
purchase price + acquisition costs + cost of major improvements(not repairs and maintenance) – deductible depreciation = net acquisition costs (“basis” in tax speak)
Similarly, the net proceeds of sale formula is as follows:
sales price – costs related to the sale (real estate commissions, closing costs, etc) = net sales proceeds
If sellers have held a property for a year or less, they must report the profit as a short term capital gain taxed as ordinary income. However, if they have held it for more than a year, they may report it as a long term capital gain which is subject to a reduced tax rate of 0%, 15% or 20%, depending on filing status and total taxable income reported on the tax return.
However, there are two other important considerations which may result in significant tax savings.
Exclusion of gain on a principal residence:
The IRS defines a principal residence as one a taxpayer has resided in for two of the prior five years. Therefore, if a second home qualifies in this respect, sellers may elect to treat it as a primary residence. They can then exempt $250,000 of the gain if filing single or married filing separately. Additionally, they may double this exemption if they file jointly. As you can imagine, this would result in an significant tax savings.
The 1031 exchange opportunity:
Sellers may be able to take advantage of a unique opportunity offered by safe harbor rules. Generally speaking, selling a second home would not qualify for tax deferral under the 1031 exchange rules that apply to real estate held for business or investment purposes.
However, if they meet certain conditions, sellers of second homes do qualify and may defer taxes indefinitely. In order to do so, they must adhere to each of the following:
(1) The sellers must own the second home for the twenty four consecutive months prior to the sale.
(2) In each of the two twelve month periods immediately preceding the sale, they must have rented the property at market rates for at least fourteen days.
(3) During each of these twelve month periods, the owners must have occupied the property for not more than the greater of fourteen days or ten percent of the days they rented the property out at fair market value. However, being present in the property for the purpose of making repairs and maintenance does not qualify as occupying the property under this provision.
(4) The real property received in the 1031 exchange must qualify. Therefore, the sellers must intend to use the property in a trade or business or hold it for investment.
(5) Within 45 day of closing, the sellers must identify the property they will acquire in the 1031 exchange. Furthermore, they must close on the identified property within 180 days.
Additional 1031 Exchange Details
The sellers may not control the proceeds of the sale of their second home. If they can direct that net proceeds be used outside the 1031 contract, they become fully taxable. However, an intermediary may hold the proceeds and transfer them to the closing agent for property being acquired. This will keep them beyond the control of the sellers and preserve the integrity of the 1031 exchange.
If carefully executed, a 1031 exchange offers an outstanding opportunity for the deferral of taxes.
Plan the selling of your second home to your best advantage:
Please consult your tax advisor to review your options and plan the structuring of your sale or 1031 exchange to maximize the benefits you derive from the transaction.
In the interest of full disclosure, please be aware that while I have practiced as a CPA for most of my adult life, I am not actively practicing now. I have served as a tax specialist for the firm now known as Price Waterhouse Coopers and taught accounting at the university level. However, I also simultaneously ran real estate businesses throughout my life and currently I am devoting all of my time to my primary passion, real estate.
Andrew Kruglanski, Broker
Ocala Home Guide Realty, LLC
Website: Ocala Homes Online