Can you avoid capital gains tax when buying another house? The answer is nuanced. If you're selling an investment property and planning to reinvest the profits into another, it is possible to defer capital gains tax. Under IRS Section 1031, if you reinvest your gains in a 'like-kind' property within 180 days of the sale, you may qualify for a deferral of capital gains tax. However, to maintain compliance with the rules, keeping your funds in an escrow account managed by a Qualified Intermediary is often necessary until the new property is purchased.
Primary residence treatment is different
We will examine 1031 exchange details shortly. However, capital gains taxes are different if you sell your primary residence. While your house is your home, it is also an investment. It may gain significant value depending on when you buy it and how long you own it. Many homeowners want to use their home equity to “trade up” to a larger or better house or as investment capital.
If you sell your primary residence, you qualify for an exemption from capital gains up to $250,000 for an individual or $500,000 for a couple filing jointly. In the past, this exemption was restricted to people who bought another house or reached a threshold age, but that's no longer the case. Current qualifications are:
- You have owned the home for at least two of the last five years.
- You have lived in the home for at least two of the last five years.
- You have not claimed a capital gains exemption for a different residence within two years.
The exemption is not tied to another house purchase or other action. The taxpayer can use the sale proceeds as they wish. If they use the appreciation from their home to buy an investment property and later sell that, the primary residence exemption won't apply.
What type of property qualifies for a 1031 exchange deferral?
As mentioned, when you sell your primary residence, you may qualify for a capital gains exemption if you meet the eligibility requirements. That exemption doesn’t apply to investment properties such as rental homes or commercial real estate. Instead, you may want to execute a 1031 exchange if you intend to reinvest the proceeds.
The property must be used for business or held for investment to become eligible. This restriction means that short-term ownership of a house to remodel or repair and sell for a profit typically does not qualify. However, if you have a vacation home that you rent to others at fair market value, you may qualify for a 1031 exchange. The determination is based on how often the owner uses the property personally compared to how much they utilize it for business. Furthermore, a short-term rental property (like Airbnb) likely qualifies.
In some ways, the IRS’ rules governing these exchanges are restrictive. For instance, there are tight deadlines for identifying and acquiring replacement property. The acquisition price for replacements must equal or exceed the sale price of the original asset. On the other hand, the IRS is generous when applying the term "like-kind property" to an exchange. Like-kind can apply to the sale of a house and buying another one, but it can also include selling a house and buying an office building or selling a retail property and reinvesting in vacant land. The point is that both the relinquished and replacement properties are for investment or business usage, not personal accommodations.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
FAQs
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
How long do I have to buy another house to avoid capital gains? ›
You might be able to defer capital gains by buying another home. As long as you sell your first investment property and apply your profits to the purchase of a new investment property within 180 days, you can defer taxes.
How can I avoid paying capital gains tax on the sale of a second home? ›
Ways to reduce your capital gains tax
- Adjust your profits to reflect any acquisition costs or property improvements. ...
- Depreciate the property if it was used as a rental. ...
- Rent out your second home. ...
- Make your second home your primary residence.
If the home is a rental or investment property, use a 1031 exchange to roll the proceeds from the sale of that property into a like investment within 180 days.13.
At what age do you not pay capital gains? ›
Since the tax break for over 55s selling property was dropped in 1997, there is no capital gains tax exemption for seniors. This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.
Can you transfer capital gains from one property to another? ›
If you're selling an investment property and planning to reinvest the profits into another, it is possible to defer capital gains tax. Under IRS Section 1031, if you reinvest your gains in a 'like-kind' property within 180 days of the sale, you may qualify for a deferral of capital gains tax.
What is a simple trick for avoiding capital gains tax? ›
Hold onto taxable assets for the long term.
The easiest way to lower capital gains taxes is to simply hold taxable assets for one year or longer to benefit from the long-term capital gains tax rate.
What is the IRS rule for second homes? ›
For the IRS to consider a second home a personal residence for the tax year, you need to use the home for more than 14 days or 10% of the days that you rent it out, whichever is greater. So if you rented the house for 40 weeks (280 days), you would need to use the home for more than 28 days.
How to offset capital gains tax? ›
How to Minimize or Avoid Capital Gains Tax
- Invest for the Long Term.
- Take Advantage of Tax-Deferred Retirement Plans.
- Use Capital Losses to Offset Gains.
- Watch Your Holding Periods.
- Pick Your Cost Basis.
Yes, since you are actually selling one fund and purchasing a new fund. You need to report the sale of the shares you sold on Form 8949, Sales and Dispositions of Capital Assets. Information you report on this form gets posted to Form 1040 Schedule D. You are liable for Capital Gains Tax on any profit from the sale.
An investor's age does not by itself affect any capital gains taxes the IRS expects them to pay upon the sale of an asset. However, you can reduce your capital gains tax obligation in other ways. The length of time you hold an investment can significantly impact the capital gains you owe.
Is profit from selling a house considered income? ›
Taxpayers who don't qualify to exclude all of the taxable gain from their income must report the gain from the sale of their home when they file their tax return. Anyone who chooses not to claim the exclusion must report the taxable gain on their tax return.
Can you spread capital gains over years? ›
Taking capital gains in different years
Another option to discuss with your tax professional may be to “spread the sale over multiple tax years — that can help ease the burden,” says Jonathon McLaughlin, investment strategist for Bank of America.
How much capital gains are you allowed in a lifetime? ›
There is no limit, either on how much you can gain from rising appreciation in assets or the amount of taxes you can owe. However, there are some exemptions and some tactics to minimize your taxes. The most well-known and widespread exemption from capital gains taxes is for homeowners who sell a primary residence.
Do capital gains count as income? ›
Capital gains are generally included in taxable income, but in most cases, are taxed at a lower rate.
What is the 2 out of 5 year rule? ›
When selling a primary residence property, capital gains from the sale can be deducted from the seller's owed taxes if the seller has lived in the property themselves for at least 2 of the previous 5 years leading up to the sale. That is the 2-out-of-5-years rule, in short.
What is the capital gains over 55 rule? ›
The over-55 home sale exemption was a tax law that provided homeowners over age 55 with a one-time capital gains exclusion. Individuals who met the requirements could exclude up to $125,000 of capital gains on the sale of their personal residences. The over-55 home sale exemption has not been in effect since 1997.
Who qualifies for 121 exclusion? ›
Qualifying for the exclusion
In general, to qualify for the Section 121 exclusion, you must meet both the ownership test and the use test. You're eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale.
How much can you write off on a second home? ›
Are Second-Home Expenses Tax Deductible? Yes, but it depends on how you use the home. If the home counts as a personal residence, you can generally deduct your mortgage interest on loans up to $750,000, as well as up to $10,000 in state and local taxes (SALT).
