Capital Gains Tax On A Second Home

Is the capital gains tax on a second home different than normal captial gains taxes?

2 Answers

The capital gains tax on a second home is no different than the capital gains tax on any other asset. A house - whether it is your first, second, or tenth - is a capital asset, and the sale of it triggers either the long or short term capital gains tax. Long term capital gains rates, which kick in only if you've owned the asset for 366 days, range from 5% to 28% of the gain on the sale, depending on your income level. Most people pay the 15% rate. The short term rate, which applies to the sale of any capital asset held for less than 366 days, is the same as your ordinary income tax rate and could be as high as 35%.

Most people know that if you own your primary residence for more than two years and then sell it, you do not owe any capital gains tax - provided your gain does not exceed a certain dollar amount. This exception does not apply to second homes. If you sell a house that is not your primary residence, which is usually the case with second homes, you must pay the usual capital gains tax. There is a way around this, however, through the flexibility of use rules.

According to the flexibility of use rules, you must have used the house you're selling as your primary residence for two of the previous five years. Those two years need not be sequential, and you need not live in the home at the time of sale. Accordingly, you could alternate years you live in your primary home and secondary home or you could live in each as your primary residence for two years. Sell one home, move to the other and wait two years, then sell the other. Upon the sale of both your primary and secondary home, you can avoid capital gains tax because you will have met the time and use requirements.

There is a caveat, though, which I briefly alluded to above. You can use the exclusion as many times as you want, but each sale must be at least two years apart. That is why the above method is ideal for someone who has the ability to live in either place - perhaps retirees or empty-nesters. If you must stay in your primary residence and need to sell your second home, you'll just have to pay the capital gains tax.

This is a very simplified answer, and there are other caveats to consider, particularly for couple and those people whose second home is a rental that they acquired through a 1031 exchange. Please consult a tax or real estate professional if you have further questions.

Section 121 of the tax code is very specific as to who, how, and when you can sell a home and exclude any gain. The code states that an Individual must have owned and used the home as a "principal" residence for at least two out of the past five years. However, there are exceptions to this 2 year requirement. The code allows for a partial or reduced exclusion of capital gain if the reason for selling a home before the 24 month requirement is met because of:

  • A change in employment

  • Health

  • Unforeseen circumstances

In order to claim a home as your primary residence you must live in the home continuously for a 24 month period. Short temporary leaves of absence for vacations or other reasons, even if the house is rented during these short absences count as time toward the 24 month requirement. ( IRS pub 523)