BizNet OnLine Magazine, How to Generate Tax-Free Income

How to Generate Tax-Free Income
Avoid Making the Sale of Your Home Taxable

by Teena A. Takata

How to Generate Tax-Free Income from Residence Sales -and How to Avoid Making the Sale of Your Home Taxable

Residence Sales - would you consider selling your home if the gain were tax-free, then buying another and generating another tax-free gain when the next home has appreciated?

Summer is a traditional time for selling a home, and it is fast approaching. Make sure you hold your home long enough to avoid having the sale taxable!

Gain on the sale of your principal residence is excluded, up to $250,000 (single) or $500,000 (married filing joint return), if you have lived in and owned your personal residence for at least two of the last five years. If you are not overcome by the huge inconvenience of moving, and the difference between the tax basis in your home and the current value is approaching $500,000 (or $250,000 single), then from a tax viewpoint you should sell the home, and reinvesting in a new home. You may repeat this over and over, as long as you wait at least two years in between each sale. Since homes don't appreciate that quickly, you probably will be waiting at least two years to generate enough gain to make a sale of your new home near enough to the $250,000 or $500,000 allowance to reach the point where you "should" sell your home.

Alternatively, if you don't need a home as big as the one you have now, you can sell it with no need to "trade up" as under the old rules. Also, under the old rules, if you were 55, you had a once-in-a-lifetime exclusion of gain available. The above rule allows you to sell your home any time after you have lived in it at least two years, and exclude those gains (up to $250,000/$500,000) multiple times. The new rules are available to you even if you have already benefitted by the $125,000 once-in-a-lifetime exclusion.

Also consider converting the gain on a rental home to a tax-free sale. If you have a rental property that has a large deferred gain, think about making it your principal residence for at least two years. Then that home would constitute your principal residence, and the gain would be excludable (up to $250,000/$500,000). This law is also a real bonanza for small contractors who are willing to live in and improve a home for at least two years, too.

A word of caution - we had a new client who did not hold his home for two years, but sold it for a $30,000 gain. He traded up (bought a new home that was purchased for more than the net sale price of the old home), while keeping his old job. He figured he wouldn't have any tax since he traded up - that is the old rule, and it no longer applies!

Gains on home sales will now be fully taxable, unless the two year holding period is met, unless exceptions in the next sentence apply. For home sales due to a change in employment that requires relocation, health issues, or "unforseen circumstances", the $250,000 or $500,000 exclusion is "prorated". As an example, if a married couple lived in, and owned the home for 1.5 years, and moved because one spouse got a job far awary, their exclusion of gain would be limited to 1.5 years/2years required, or 75% of $500,000, or $375,000.

Teena A. Takata is a CPA who has worked primarily in the tax area for the last 20 years. Her firm specializes in tax planning (ie, minimization) for middle to small sized businesses, and also assists individuals and businesses who may not have filed for several years get current and back into the system. Her preferred small business accounting software is Quickbooks Pro, which she supports through email with many clients. She can be reached by email at Teena@besttax.com, but advises us she likely will not be able to answer tax questions from non-clients until after April 15^th. If the above made your head spin, but you believe some opportunities may exist to minimize your tax, you may want to extend your return to provide you more time to study, and/or consult with a qualified tax preparer! We help educate our clients when they ask for help. You can also email Teena to sign up for her periodic newsletter, issued three to four times a year, that covers a variety of tax and business suggestions.

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