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We have a second home – a condo in the mountains – that was bought with cashfor $295,000 approximately six years ago. It’s now worth at least $500,000. We are considering selling as our use is declining and maintenance costs and special assessments of the three-building complex are increasing. What are the options to decrease our tax liability on the $200,000 profit, and what would be the best investment advice for two 75-year-old retirees?
– Mary
I certainly understand wanting to reduce your tax liability on the profit from selling your property. You’ve already cleared the biggest hurdle to reduce your tax bill, which is to make sure you’ve held it for longer than one year to take advantage of the lower long-term capital gain tax rates. You may be able to eliminate your tax bill, and there are some things you can do to moderately reduce your tax bill on the sale of a second home. I’ll offer some things to think about here but you should consult your personal tax advisor before making any moves. There’s a lot of your story that I simply don’t know. (And to speak to a financial advisor about your personal scenario, use this advisor matching tool.)
Although this might not be a practical option, I feel like I’d be remiss to not mention it: a married couple can exclude up to $500,000 of capital gains on the sale of their primary residence (individuals exclude up to $250,000).
“That’s neat Brandon, but I already told you this is a second home,” you’ll say.
Yes, but it is possible to make it your primary residence by meeting a few requirements. There are additional details to consider, but I imagine the main hurdle for you is passing the residence test. Essentially, if you live in the home for at least 24 months within the five years preceding the sale you can satisfy that requirement.
This two-year period doesn’t need to be consecutive. The Internal Revenue Service allows you to aggregate the time you spent living in the home during the five-year pre-sale window. However, the IRS also notes that you’re typically “not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.”
Again, I understand this may be a bridge too far but if you consider how many months you’ve already stayed there in recent years then you may find that staying there for a short period – and holding off on the sale –could eliminate your tax burden. (And if you need additional help sorting through these types of decisions, speak with a financial advisor.)
A married couple can exclude the first $500,000 in capital gains they realize when selling a primary residence.
If you’re unable to meet the IRS’s use test and need to reduce your tax liability on the sale, you’ll want to think about all the deductions you can take that relate to the property and its sale. For example, if you make upgrades to the home then those may increase the cost basis and reduce the size of the capital gain you realize when you sell.
You’ll also be able to deduct the expenses related to the sale of the property, such as advertising and transaction costs. The biggest is probably going to be the realtor’s commission if you don’t sell the home yourself.
Again, your tax preparer will be able to walk you through these deductions and may be willing to help you estimate the taxable portion of a sale beforehand.
Of course, you could just not sell your second home. If you keep it to use as a rental then you’d incur a tax liability on the rental profits, but you’d also have the additional income. (And if you need additional financial advice, this matching tool can help you connect with advisors.)
A retired couple looks over their portfolio and considers investing in some new assets.
If you sell the home and invest the proceeds, make sure you invest with your goals and longevity in mind. I’m a huge proponent of broad diversification using index funds to create a portfolio in an asset allocation that’s appropriate for you.
Retirees who are 75 years old will generally be better off with portfolios that lean toward the conservative side, but it greatly depends on the rest of your holdings, income sources, goals and risk tolerance. You’ll need to investigate these considerations deeply on your own or work with an advisor to get personalized advice.
The easiest way to avoid taxes on the sale of your second home is to not make any money doing it. Considering that isn’t a desirable outcome, you may want to consider whether taking advantage of the primary residence exclusion is possible. If not, make sure you account for all the deductions available to you. When it comes time to invest the net proceeds, the right plan is going to depend on your goals, your other assets and risk tolerance.
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Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor is he an employee of SmartAsset, and he has been compensated for this article. Questions may be edited for clarity or length.
