*Note: This blog is geared toward our American friends, but those of you reading from around the world might also have a similar benefit in your tax code.
The IRS wants to give you a generous gift.
I know that’s hard to believe.
Yet, so few people take advantage of it on a regular basis.
I’m talking about Publication 523 in the IRS code on the Home Sale Exclusion.
Here’s basically how it works:
If you’ll buy a home & live in it as your primary residence for at least 2 years, then when you go to sell it, you can take up to $500,000 profit TAX FREE for married couples ($250,000 for singles).
You might want to read that again.
Since when do you ever get tax free profit on anything?
Yet, in this case, the IRS will give you tax free profit on the sale of your home as long as you meet certain qualifications.
Here they are:
- You must not have bought your home in a 1031 exchange during the past 5 years or are subject to an expatriate tax (chances are if you don’t know what those are, they don’t apply)
- You must’ve owned the home for at least 2 years out of the last 5 years leading up to the date of the sale.
- You must’ve owned the home AND used it as your primary residence for 2 of the last 5 years.
- You must not have sold another home during the 2 years prior to the sale of your current home where you took the benefit (in other words, you can only get the benefit every 2 years).
There are some exceptions to these qualifications that you can read about in the IRS guide, like divorce, death, or member of the military.
One other benefit of this rule is that if you haven’t lived in your home a full 2 years, but you change workplace locations, have a health issue, or another unforeseeable event happens, you could qualify for a partial exclusion. My wife and I were able to use this when we lived in a house for 1.5 years but moved locations due to work. We were still able to take all of the profit tax free due to this partial exclusion.
Ok, enough of the technical details.
Here are some examples of how this could work:
Example #1: You buy a home for $300,000, add some value to it, and 2 years later you make $70,000 tax free profit when you sell it, assuming you meet the qualifications above. $70,000 tax free is worth a lot more than $70,000 because if you make $70,000 gross at your job, you may only take home ~$50-60k. That’s a big chunk of extra cash!
Example #2: You buy a home for $200,000, add some value, & sell it 3 years later making $60,000 in tax free profit. Then you buy another home for $200,000, putting $60,000 down as a down payment. You add some value & sell that home for another $60,000 in tax free profit 2 years later. Then you buy a 3rd home with CASH for $120,000 and you have no mortgage payment! Wow!
Example #3: Let’s say you live in California or New York or some other extremely expensive place. This is where the benefit really shines. Let’s say you purchase a home for $1,000,000. You add value & 5 years later you sell it for $450,000 in tax free profit! Wow! Remember, in the Home Sale Exclusion you can take up to $500,000 tax free profit if you’re married ($250,000 if you’re single). So, even though you made $450,000 when you sold your home, you don’t pay ANY capital gains taxes on that money. Totally amazing!
This is how my wife and I were able to pay off our home so quickly! We would buy a house, add value to it, & sell it for a profit. Then we’d take that profit & put it down on another house, add value, & sell it again for a profit. We kept doing this until we paid cash for a house. You can read more about that here: How to Pay Off Your Mortgage in 6 Years
I know moving can be a pain, but I believe a mortgage payment is an even greater pain!
We were willing to put up with moving a lot to get rid of the mortgage payment because we knew that payment was slowing down our road to financial independence.
Taking advantage of this IRS Home Sale Exclusion every few years can produce great supplemental income for you & your family!
*Here is Publication 523 where you can read more: https://www.irs.gov/pub/irs-pdf/p523.pdf
