By Sean Colón
Selling a second home, whether it’s a vacation retreat, investment rental, or inherited property, often carries a hidden burden: capital gains tax. Unlike a primary residence, second homes do not qualify for the preferential exclusion under the Taxpayer Relief Act. That means sellers may face up to 20% or even 25% federal tax on profits (with state tax on top) unless strategic planning is used.
For Arizona Realtors advising clients, understanding these tax realities is not optional. It’s part of your value to protect sellers and help them keep more of their proceeds.
How Capital Gains on a Second Home Are Calculated
At its core, capital gains tax applies to the net profit: sale price minus original purchase price, minus allowable adjustments (improvements, closing costs, depreciation, etc.).
If the property was held for 1 year or less, gains are taxed at ordinary income rates (known as short-term gains).
If held longer, it’s subject to long-term capital gains rates, which range from 0% to 20%, depending on taxable income.
For Arizona residents, an additional 2.5% state tax applies to the gain.
So a client who sells a second home in Phoenix for a gain of $200,000 may owe a steep tax liability when federal and state rates combine.
Three Strategies Sellers and Realtors Can Use to Reduce or Defer Capital Gains
1. Use a 1031 Exchange
A 1031 like-kind exchange allows sellers of investment property to defer capital gains tax by reinvesting proceeds into another qualified property. In Arizona, this deferral applies to real estate held for investment or business use—not personal vacation homes.
Key rules:
Identify replacement property within 45 days
Close on the replacement within 180 days
Use a Qualified Intermediary to hold funds, so sellers never directly control proceeds during the exchange
This strategy allows clients to roll gains into another investment and defer tax liability until a later sale.
2. Convert the Home into a Rental or Investment Property
By converting the property from personal use into a rental or business property, clients may better position themselves to qualify for a 1031 exchange later. Over time, the property must be treated income-producing, with records, leases, and consistent rental management. Some sellers first transition to rental status for a period before executing a 1031 to gain eligibility.
3. Make the Second Home Your Primary Residence (If Eligible)
If a seller lives in the second home for at least two of the five years preceding sale, they may claim the $250,000 (single) or $500,000 (married) exclusion on capital gains. (IRS)
Caution: This strategy requires careful timing, because buyers must meet strict residency rules and limitations on past use. Sellers should run projections to ensure the exclusion will cover their anticipated gain.
| Taxable income | Filing status | Capital gains rate as of 2024 |
|---|---|---|
| < $47,025 | Single or married filing separately | 0% |
| < $94,050 | Married filing jointly or qualifying surviving spouse | 0% |
| < $63,000 | Head of household | 0% |
| $47,025 – $518,900 | Single | 15% |
| $47,025 – $291,850 | Married filing separately | 15% |
| $94,050 – $583,750 | Married filing jointly or qualifying surviving spouse | 15% |
| $63,000 – $551,350 | Head of household | 15% |
| > $518,901 | Single | 20% |
| > $291,851 | Married filing separately | 20% |
| > $583,750 | Married filing jointly or qualifying surviving spouse | 20% |
| > $551,351 | Head of household | 20% |
Why Realtors Who Understand Tax Planning Stand Out
Clients often ask “How much will I net after taxes?” A Realtor who can speak confidently about capital gains implications—not just market value—becomes a trusted advisor, not just a listing agent.
In Arizona, with robust investment property activity and vacation markets, many sellers do not realize how much tax they might owe. By guiding them through options like 1031 exchanges or residence conversion, you help them retain more of their equity—and differentiate your service.
Remember, 1031 exchanges and exclusions are complex and require expert tax advice. Your role is to educate clients on possibilities and connect them with qualified CPAs or tax attorneys.
If you’re preparing a listing that clients consider “their second home,” include a conversation early about capital gains strategies. And when it’s time to showcase that property for sale or for investors, your listing deserves photography that highlights investment potential, visit seancolon.com to see how professional real estate photography can elevate your marketing and client value.
Your turn:
Have you ever recommended a 1031 exchange to a seller in Arizona? Did it help close the deal or retain more profit for them? Share your stories in the comments! I’d love to hear how Realtors here are navigating capital gains with clients.
By the way, I help realtors improve their online and social media presence by providing beautiful photos of their listings. That is why I’ve created this FREE HOME PREP LIST for your clients to help your listings look their best. Feel free to share.