Capital gains tax is the tax you pay on the profit from the sale of an investment such as real estate. There is an exclusion of $250,000 per owner of a primary residence ($500,000 for a couple), but if you buy a new home and then rent your prior home instead of selling it at that time it becomes an investment property. When you decide to sell it will be subject to capital gains tax because it is no longer your primary residence.
You can, however, defer that tax if you swap it for another investment property using a 1031 Exchange. The new investment property could potentially even be a vacation home if you rent it for part of the year.
I am not an accountant so please consult your tax accountant before making any decisions, but here is some info on 1031 exchanges to give you food for thought.
- In real estate, a 1031 Exchange is a swap of one investment property for another of 'like kind' – in other words, you cannot use a 1031 Exchange to sell your primary residence and buy investment property or sell investment property and buy a primary residence
- A vacation home might be considered an investment property if you can show that in each of the two years prior to the exchange you had paying tenants for at least part of the year and you did not use the home for more than 10% of the total number of days the home was rented in a 12-month period
- If you don't close on your replacement property at the same time as your sale, proceeds from the sale of your relinquished property must be held by an independent third party intermediary (not your attorney, agent, broker or CPA) until you are ready to buy your replacement property
- You must identify the replacement property (or properties) within 45 days of the sale of your relinquished property and close within 135 days after that
- You can add more cash to buy a more expensive property, but if you don't use all your profits from your sale any cash left over will be taxed as partial sales proceeds, generally as a capital gain
- If you don't receive any cash but your liability on the new property goes down, that will also be treated as income to you just like cash
Again, I am not an accountant. If this sounds like a possibility for you, research more about it and discuss it with your tax accountant.