Ask an Advisor: From $295K to $500K - How Can We Lower Taxes on Selling Our Second Home?

As a homeowner, you may have considered selling your second home to unlock its value and reinvest the proceeds into other assets or experiences. However, the thought of paying capital gains tax on the sale can be daunting. In this article, we'll explore strategies to help you minimize your tax burden when selling a second home, using a hypothetical scenario where a couple aims to sell their second home for $500,000, with a current value of $295,000.

Understanding Capital Gains Tax on Second Homes

When you sell a second home, you're subject to Capital Gains Tax (CGT) on any profits above your annual allowance. In the UK, the CGT allowance for individuals is £12,300 (tax year 2024/2025), and for married couples, it's £24,600. The CGT rate is 24% for gains above the basic tax rate, but it can be reduced to 18% for basic rate taxpayers if their income doesn't use all of their basic rate band.

Strategies to Lower Taxes on Selling a Second Home

1. Primary Residence Capital Gains Exclusion
Utilizing the primary residence capital gains exclusion can help minimize taxes on selling a second home. Married couples can exclude up to £500,000 in gains from capital gains taxes when selling their primary residence, while individuals can exclude up to £250,000. To qualify for this exclusion, the home must have been used as your primary residence for at least two out of the five years preceding the sale. If you have lived in your second home for at least two years, you may be able to apply this exclusion to the sale of that property as well.

2. Marriage Allowance
Married couples and civil partners may be able to reduce the overall tax charge by transferring the property into joint names or changing the ownership split between them. This allows them to split the gain between the couple and use each person's annual CGT allowance. By doing so, they can potentially reduce the overall tax charge. However, it's important to review these options before agreeing to a sale, as the ownership position cannot be changed once the property is sold.

3. Private Residence Relief
If you have more than one property that you use personally, you can make an election to have HMRC nominate one as your primary residence. This nomination must be made within two years of acquiring a new property. Without this nomination, HMRC will allocate the relief based on actual occupancy, which may not be the most tax-efficient solution for you. Additionally, if you are required to live elsewhere because of work, you may still be able to claim main residence relief on your home. However, this relief does not apply to all jobs, and there may be additional conditions to qualify.

4. 1031 Exchange
A 1031 exchange is a tax-deferred exchange that allows investors to sell a property and reinvest the proceeds into a new property without incurring immediate capital gains tax. This strategy can be particularly useful when selling a second home. To qualify for a 1031 exchange, the property being sold must be held for investment or business purposes, and the new property must also be held for investment or business purposes. In the context of a second home, this typically means that the property must be rented out for at least 14 days or more during the tax year, and the owner cannot use the property for personal purposes for more than 14 days or 10% of the total days rented, whichever is greater.

Example: Lowering Taxes on Selling a Second Home

Let's consider a couple who owns a second home valued at £295,000, with a purchase price of £150,000 and improvements costing £30,000. They plan to sell the property for £500,000. Using the strategies mentioned above, they can potentially lower their tax burden as follows:

1. Primary Residence Capital Gains Exclusion: If the couple has lived in the property for at least two years, they can exclude up to £500,000 in gains from capital gains taxes. In this case, their gain would be £160,000 (£500,000 - £295,000 - £30,000), which would be fully covered by the exclusion.
2. Marriage Allowance: By transferring the property into joint names or changing the ownership split, the couple can split the gain between them and use each person's annual CGT allowance of £12,300. This would result in a tax bill of £0, as the gain would be fully covered by the allowances.
3. Private Residence Relief: If the couple nominates this property as their primary residence, they can potentially qualify for private residence relief, further reducing their tax liability.
4. 1031 Exchange: If the couple uses a 1031 exchange to purchase a new rental property, they can defer paying capital gains tax on the sale of the original property until they sell the new property or pass away.

By strategically using these tax-saving strategies, the couple can potentially lower their tax burden when selling their second home, allowing them to keep more of their hard-earned money.

Conclusion

Selling a second home can be an exciting opportunity to unlock its value and reinvest the proceeds into other assets or experiences. However, it's essential to consider the tax implications and explore strategies to minimize your tax burden. By understanding the primary residence capital gains exclusion, marriage allowance, private residence relief, and 1031 exchange, you can potentially lower your taxes on selling a second home and keep more of your hard-earned money. Always consult with a tax professional or financial advisor to ensure the best possible outcome tailored to your specific situation.