Prize for second place? Higher taxes.

Thinking about buying a second home, either for vacations or as a rental property? With real-estate prices well below their pre-recession levels and with mortgage rates still reasonable, many folks are starting to shop around. If you're one of them, there is a special tax provision you should know about. If you sell your primary residence, you don't have to pay capital-gains taxes on up to $500,000 in gains if you are married and up to $250,000 if you're single--provided you have lived in the home for at least two out of the last five years running up to the sale.

Thanks to a recent tax-law change, however, things are a little rougher for owners of second homes. Previously, if you moved into a second home and used it as your primary residence for at least two years, you got the same $500,000 or $250,000 exclusion when you sold.

But as a result of a law that took effect in 2009, second homes converted to primary residences no longer get the full exclusion. Instead, under the new law, a portion of the gain will be taxed, depending on the years of nonqualified use--the time the property was a vacation home or rental unit--compared with the number of years it was a primary residence.

For example, say a married couple owned a second home for six years. They rented it for four years and then lived there themselves for two years. Under the old law, if they sold it for a profit of $300,000, they would have been eligible for the full exclusion and wouldn't owe any tax.

But under the new law, four-sixths of the gain, or $200,000, would be taxable, while only two-sixths, or $100,000, would be eligible for the exclusion. If they had hung onto the property and continued to live there, they would gradually come to owe less and less tax on the profit. For further information, you should contact a tax advisor.

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