GMAC Real Estate The Taxpayer Relief Act of 1997 and Second Homes
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The Taxpayer Relief Act of 1997 and Second Homes

Takeaways

  • This congressional action created a new capital gains tax exclusion on the sale of a primary residence.
  • The exclusion is up to $500,000 for couples and $250,000 for single homeowners.
  • Second homes must be converted to primary residences to qualify for this tax break.

Did you know?

  • Any depreciation claimed on previous investment property before May 6, 1997 is forgiven and not subject to a recapture tax.
A tax-free windfall from Congress. After Congress passed the Taxpayer Relief Act of 1997, second home owners and prospective owners should have sent candy and flowers to their representatives and senators. The reason is twofold – moving into a second home that was previously rental property is not a taxable event, and homeowners can sell their primary residence every two years and pay no tax on gains less than $500,000 for couples and $250,000 for singles.

In practical terms, imagine owning a home as well as an inherited lake house. A married couple can sell the original permanent residence with a $450,000 gain on the sale and not pay a penny of tax on that windfall. This couple moves into the lake house and remains in the one-time second home for more than 24 months. Once two years of residency has been established that couple can sell the lake house at another large gain and so long as the gain is below the $500,000 threshold that gain is completely tax-free as well.

All this "free" money is completely above board thanks to the Taxpayer Relief Act of 1997. The one place you might face a tax hit on a rental second home converted into your primary residence is in the depreciation claimed on the real estate when it was a rental. For this law the cut-off date is May 6, 1997. Any depreciation taken before that date is forgiven, depreciation claimed after the date is subject to "recapture" by the IRS and will be taxed.

Meeting the Requirements

The key to meeting residency requirement for the Taxpayer Act of 1997 is owning and using the home as the main residence for no less than two of the five years immediately previous to the date of sale. For a couple only one person is required to meet that requirement. For example if you take a short-term or uncertain job in another city and your spouse elects to stay behind, you can purchase a second home and once you’ve lived in it for two years either home you own can be sold with the tax break. Or if you move to a new city, you can keep your previous primary residence as a rental and sell it anytime within the next three years retaining the tax break on up to a $500,000 capital gain.

The Act and 1031 Exchanges

Things are a little trickier when the second home is involved in a 1031 exchange. The tax deferred 1031 exchange is designated only for investment property, so any second homes acquired through a 1031 exchange need to be investment rental homes for a period of time before being converted to a personal residence. There’s no set time limit for how long you must let the property remain a rental, but a good rule of thumb is have two years of taxes showing the second home as a rental before moving in to start the two year residency process.

Search for Second Homes for Sale

To search for a selection of second homes for sale, please visit lifestylehomesearch.com, or visit the website of a GMAC Real Estate Office that serves the area where you'd like to buy a second home. To learn more about buying Second Homes or Vacation Homes, explore the rest of this section, or contact a GMAC Real Estate Agent.