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Question for the Money Doctors

Question submitted on Oct 18, 2022.


How do I shelter the capital gains from the sale of a vacation home I have owned for 15years. I am 59 years old


There are several considerations when you are dealing with capital gains from a second home sale.  This largely depends on your personal tax situation, how frequently you used the home personally and other factors such as if you rented it or not, for example.  You will want to evaluate how this correlates with the other income sources you have, retirement accounts, your individual tax bracket, and your overall financial situation.

However, there may be some ways to reduce, defer and/or eliminate the capital gains on the sale.  Some items to consider include: 

  • Did you have any renovations or repairs over the years that could be deducted from the profit of your sale?  Any capital improvements you spent on the home over the years would add to the cost basis and thus reduce your capital gain.
  • Deducting the expenses of the sale from when you purchased the home (realtor commissions, inspection fees, etc.) as well as when it is sold.
  • These would be helpful if you intend to take the proceeds of the sale and pay the tax on the capital gains. 

Another option would be a Section 1031 exchange.  In the most simplistic terms, when a property is held for investment, the seller can direct the proceeds from the sale of the property into the purchase of a replacement property.  The capital gains have an opportunity to be deferred into the replacement property.  This technique is complex and generally requires experienced professionals to assist with the transaction.  Some of the basic rules are as follows: 

  • Proceeds from the sale cannot be received by the seller and must be held in escrow by a third party.  i.e., Qualified Intermediary
  • The replacement property(ies) must be identified within 45 calendar days of the sale date of the sold property.
  • The replacement property(ies) must be purchased within 180 calendar days of the sale date of the sold property.
  • The replacement property(ies) must be of equal or greater value of the sold property to avoid any taxable gain (“boot”).
  • The properties being exchanged must be considered like-kind by the IRS. 

Again, these are some basic comments and not intended to be specific advice to any transaction.  Professionals with expertise in 1031 exchanges can assist further. 

A relatively newer option in the last few years would be to invest in a Qualified Opportunity Zone through a Qualified Opportunity Fund (QOF).  This can temporarily defer the tax on the gains for the amounts invested.  A QOF is an investment vehicle that files either a partnership or corporate federal income tax return, is organized for the purpose of investing in QOZ property and elects to self-certify as a Qualified Opportunity Fund. The investor then has an opportunity to defer tax on eligible gains invested in the QOF until there is an inclusion event (an event that reduces or terminates the qualifying investment) or by December 2026, whichever is earlier.  The amount of time a QOF investment is held contributes to the tax benefit you receive.  The QOF basis increases the longer the interest is held.  As with the 1031 exchange, this is not intended to be specific advice to any transaction, and these transactions can have significant complexity.  Thus it is generally best to work with professionals that have the appropriate expertise and experience. 

Lastly, you have the option, if possible, to live in the house as your primary residence for 2 of the preceding 5 years before the sale.  Then, since it would be considered a primary residence, the capital gains exclusion would be available ($250k single, $500k married filing joint) to offset the capital gains.  Proper structure is critical here and it must be your bona fide primary residence.  This is not specific advice and the appropriate CPA/PFS professionals versed in this can assist if it is an option in your situation. 

For the above options, please keep in mind you will want to have thorough records readily available to provide in the event of an IRS audit.  The rules are very specific on the transaction structure and documentation required. 

We would suggest meeting with the appropriate professionals who have an understanding of the unique details of your financial situation and can guide you through the process for any of the above strategies.  Best wishes with minimizing any large capital gains.

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