Taxation of Gain on Sale of Real Estate

This article was featured in the Personal Finance section of El Nuevo Herald on Sunday, March 27, 2016. Please find the link to the published article at the bottom of this post.

We’re starting to see the value of real estate increase, which means that people are starting to see the benefits of appreciation in homes they own.  On that note, it is important to have an understanding of the tax implications associated with the sale of real estate as well as planning opportunities.

The rules vary depending on the use of the property.  Here we’ll cover 3 basic scenarios – Personal residence, a 2nd vacation home and a rental property.

Personal Residence:  The gain on the sale of a personal residence is taxable but there is an exemption to the taxable amount if certain requirements are met, which we’ll discuss briefly.  The loss on the sale of a personal residence is not a deductible loss since it is a “personal-use” property.

The gain on the sale of a personal residence may be excludible if you owned and lived in the house (as your personal residence) for 2 out of the prior 5 years. If you meet that test, you may be able to exclude up to $250,000 of the gain if you are single and up to $500,000 if you are married.

2nd Vacation home:  The gain on the sale of a 2nd home is taxable.  There is no exemptions like the one available for a personal residence.  Similarly, the loss on the sale of a 2nd vacation home is not deductible.  This is the worst of all scenarios.

Rental Properties: This is now a “business use” home.  Similar to both personal residence and vacation homes, the gain is taxable.  The loss, however, may be deductible and available to offset other ordinary income.  There are no exemptions available for the gain on the sale of rental properties like the one available for personal residences.

There is however, one major planning opportunity.  That is something called a “1031-Exchange”.  A “1031-Exchange” allows the owner to sell the home and as long as the proceeds from the sale of the rental property are reinvested for another “business-use” property, the gain is deferred until the sale of the second property.  Simple enough, right?  Well it really is, but in order to take advantage of this strategy, the sale has to be conducted through what is called a “Qualified Intermediary”, that is a company that handles the exchange of the old property for the new property in such a way that the cash from the sale never gets into the hands of the owner.  The tax laws are very specific in the way a “1031-Exchange” has to be followed or the gain will be taxed.

This can be a great opportunity to defer the payment of tax on the sale of a “business use” property until a later date, especially if you were planning to replace the property anyway.

With this, and any other, tax planning strategy, it is always advisable that you speak with your accountant or financial advisor.

Link to article in El Nuevo Herald:

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