Capital gains tax is a big deal when selling a property. Of course, you only have to pay taxes on any profit or “gain” you make from a sale. Many people wonder if a Section 1031 tax-deferred exchange is an option for them. 1031 Exchange Place notes, though, that this depends on what type of property you are selling.
You could get tax breaks from selling your primary and vacation homes. Here are some things you should know.
Principal residence exclusion
The Internal Revenue Code gives you a break when you sell your primary home. You can shield up to $250,000 of your profit from capital gains tax. If you have a wife or husband, that goes up to $500,000.
For example, if you and your spouse bought a home for $250,000, and you sold it for $350,000, your capital gains is $100,000. You do not have to pay any taxes for that. You could also use the money any way you want.
Selling a vacation home is not the same as selling a primary home. You cannot get the same tax break. However, you can do a 1031 exchange if you can prove it is an investment property.
For example, if you have a beach house, you have to rent it out. You have to show you have rented it out to other people for a total of at least one year. If you can wait that long, you may be able to do a 1031 exchange and not pay capital gains tax at the time of the sale.
Of course, you have to exchange it for like-kind property. This means you have to treat the replacement like an investment property for at least two years.
If you want to turn an exchanged property into your home, you can do that if you follow safe harbor rules. Someone has to pay you a fair rent for at least 14 days in the two years following the exchange.
You can stay in it for personal use. However, you cannot stay for more than 14 days or 10% of the time you rented it out for that year. After that, you can use the exchanged property for your personal use.
However, you cannot sell that property at once and expect to use the principal residence exclusion. You have to wait five years after the exchange to do that.
You can get tax breaks from selling your home. A 1031 tax-deferred exchange can work for vacation homes. However, you have to follow the rules.