Improving tax treatment for sale of second home


September 11, 2005

Q: I am currently a resident of Florida and only use my Maryland house for a few months each summer. I will be facing capital gains tax at some point in the future when I sell my Maryland house.

I know that with investment property, you can arrange a sale so that the capital gains can be deferred if you put the proceeds into another investment property of equal or higher value. However, my Maryland property is a second home, not an investment property.

Would it be possible to sell my second home, put the money into an investment property and defer the capital gains?

A: The gain on the sale of a second home that is neither your principal residence nor held for investment is taxable. A lower capital gains tax rate applies if you have owned the property for at least one year. You cannot defer the gain by exchanging the second home for investment property because you have not held the home for investment.

However, you may consider changing the status of your Maryland property to make the sale eligible for more favorable tax treatment.

For example, you may declare the Maryland home as your principal residence by living in it for more than six months in the year of sale. You would file a Maryland income tax return for that year and become a nonresident of Florida. After the sale, you would resume Florida residency.

Another possibility is to rent your Maryland property prior to selling it, so that it can be considered investment property. You might find a buyer who is willing to enter into a lease/purchase agreement that could qualify your Maryland home as investment property. The gain on the sale could then qualify for tax-deferred treatment if you purchase another investment property with the proceeds. You must carefully follow IRS regulations dealing with tax-deferred property exchanges.

These ideas are only suggestions. They may not work in your particular situation. You should explore your options with your tax adviser. There may be other steps you can take, consistent with your overall financial situation, to minimize income taxes on this sale.

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