Pay less tax when you sell your home

Most people are aware that there is a home sale exclusion that allows homeowners to exclude up to $250,000 for individuals and up to $500,000 for married couples. This exclusion applies to gains from the sale of your primary home as long as if you have owned it and lived in it for two out of the five years before the sale.

The IRS rules say that this exclusion can’t be taken if you have taken the home sale exclusion within the two years before the sale. However, as long as you meet these requirements, you can keep taking the exclusion over and over again, and that means that if you plan carefully and pay attention to timing, you can take a sizeable exclusion as often as every two years.

$1.5 Mil in Five Years?

By way of example, say that a married couple has lived in their home for several years, and also owns a second home. If they sell their primary residence, which they have lived in for at least two years, then they are eligible to take as much as a $500,000 exclusion on any gains they earned on the sale of the house. They then move to their second home and establish it as their primary residence.

As long as they live there for a full two years after the sale of their first house, they can then repeat the process and sell it and take the home sale exclusion on any gains up to $500,000 again – and if they then decide to purchase another home, make it their primary residence and invest in fixing it up so that they make a sizeable gain on the sale again in the future, they can do it again in another two years.

The government does not place a limit on how many times you take advantage of the home sale gain exclusion – they only care that you stick to the rules and meet the requirements, and that means that a married couple that planned and timed things perfectly could exclude a lot of money – conceivably as much as $1.5 million – in less than five years.

How About Rental Properties?

It is possible to take advantage of these rules for rental properties also, but the process is trickier and the tax exclusions are not likely to be as great. Based on the same rules the taxpayer would have to use the rental property as their primary residence for a minimum of two years before the sale.

But because of a law that Congress passed that barred the exclusion of gains for rental properties after 2008, the exclusion would only apply for gains that can be shown for a brief window, defined as before 2009 but periods after 2008 that you occupy it as your primary residence.

To understand how this works, assume that you’ve owned a rental property since July 1st of 2005 and started occupying it as your primary residence on July 1st of 2013. If you sell the property two years and one month later on August 1st of 2015 for a gain of $230,000, that means that the total time that you owned it was 121 months, 67 of which were prior to 2009 or included months that you used it as your primary residence after 2008.  Dividing 121 months by 67 months gives you .5537, and that is the percentage of the gain that you can take the exclusion on. The total gain that qualifies would equal $127,351. We specifically used a gain amount that did not exceed the exclusion limits to keep things simple.

It is important to remember that the two years of ownership requirement switches to five years for properties purchased through a tax-deferred (Sec 1031) exchange from another property.

Because these rules can get complicated very quickly and careful planning is required, it is a good idea to work with a qualified professional before attempting to optimize the home sale exclusion in this way.

If you have questions concerning the tax ramifications of selling your home, contact Gordon McNamee at (909) 949-4898.