We have two homes and want to sell. How to save on taxes?

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Q. I have a condo in Ocean City at the Jersey shore and one in Gloucester County. The condo at the shore is too small to live there permanently. We definitely want to sell both homes. Should we sell the Gloucester County house first and live at the shore until we find a place to live? We’re looking in New Jersey and other states. Or should we sell both together and rent until we find something? I don’t want to pay capital gains tax. The Ocean City condo was inherited in 2007 and is worth about $380,000. The Gloucester County home is our primary. It was purchased in 2005 and is worth about $650,000.
— Seller

A. Congratulations on having choices.

Given the surge in real estate prices over the last several years, it’s no surprise that many folks are taking advantage of the current housing market and looking to sell their homes.

But as your question shows, many people are grappling with capital gains on sales, and that can translate to confusion at tax time.

When you sell a home in New Jersey, you are required to pay taxes on the taxable gain regardless of whether the home was a principal residence, second home or investment property, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

However, how much of your capital gains get taxed is different for your primary residence and your vacation property, he said.

DeFelice said when you sell your primary residence, you may qualify to exclude all or part of the gain from your income. Single filers can qualify to exclude up to $250,000 of gains. Joint filers can qualify to exclude up to $500,000 of gains. This is true regardless of age, as long as you owned and lived in the residence for two of the five years prior to the sale, he said.

“If your capital gains are more than the $500,000 exclusion amount, you would pay tax both at the federal and New Jersey state level on the excess,” he said. “Since you have lived in the home for more than one year, you will pay federal tax on the remaining amount of gains at a rate of 0%, 15% or 20% depending on your income and filing status.”

At the state level, New Jersey taxes capital gains as ordinary income, with rates that range from 1.4% to 10.75% percent, he said. Note that the top 10.75% rate only applies once your taxable income exceeds $5 million, he said.

It also should be noted that you can add any capital improvements you made to the home as well as any fees associated with the sale of the property — commissions, legal fees, realty transfer fees, escrow fees, inspections — to your cost basis to lower the ultimate tax impact if gains are above the $500,000 exclusion threshold, he said.

“You would certainly want to sell the Gloucester County home first to take advantage of the tax break,” he said. “However, when it comes to selling a second home, unfortunately you cannot take the capital gains exclusion again, regardless of whether it is a vacation home or rental property.”

If you sell both homes at the same time, you will have to pay tax on all of your capital gains on the Ocean City condo at long term rates since you’ve owned it over one year. So if avoiding tax is your primary goal, you may need to come up with a different strategy, he said.

Here is one idea that may work for you.

You can exclude capital gains from the sale of a primary residence once every two years, DeFelice said. If you want to claim the capital gains exclusion more than once, you’ll have to meet the usage and ownership requirements at a different residence, he said.

“So in your example, if you sell the Gloucester County home now and then start living in the Ocean City condo while you are looking for your new home, you can start the clock on a new two-year period,” he said. “Essentially you want to turn your second home into your primary residence, which will make you eligible for another $500,000 capital gains exclusion.”

Depending how long it takes you to find your next home, this may work if you can deal with living in a smaller place for two more years, he said.

Also remember that the definition of primary residence is the most important factor when going about making your second home your primary residence, he said.

“You must have lived in it the majority of the year (6 months+1 day) in any given year for two out of the last five years,” he said. “That is the safe harbor that will get you there, and the tests, facts, and circumstances that prove a home is your primary residence in the event of an audit may include things like your place of employment, where you have your mail sent, where you bank and even where you go to church.”

If you find your new dream home before the two-year period is up and you can afford to purchase it without selling the Ocean City condo, you can still make this strategy work, DeFelice said.

“You can go back and forth between the two homes but would just need to spend 6 months and a day living in the Ocean City condo and be able to show proof you did so for two out of the next five years,” he said. “If you meet these criteria you should be able to `double-dip’ into the exclusion and avoid paying tax on most if not all of the capital gains.”

Real estate taxes can get complicated fast. Before making any decisions you should consult a qualified tax professional who has experience with property transactions, DeFelice said. They can help you determine your net profits and further identify opportunities to mitigate your capital gains tax so you don’t pay more than you absolutely must.

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This story was originally published on Sept. 7, 2023.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.