With a few smart moves (literally), you can avoid capital gains taxes on selling a house. That’s good news. But even if you don’t have a gain, I still have good news for you. You don’t have to worry about taxes (but you should still read this post and you’ll see why in a minute).
The laws governing capital gains on home sales changed in 1997.
Prior to that, you had to buy a new home and plow the profits back into another home if you wanted capital gains tax relief. To make it harder, you had to be 55 or older and you could only exclude a maximum of $125,000 of the gain. Many people mistakenly believe that these rules are still in place. But things have loosened up big time and you need to know about it.
If you’re single, you can exclude $250,000 in gain, and if you are married, you can exclude $500,000 when you sell your home. To sweeten the deal, it doesn’t matter how old you are.
Let’s take an example. Say you are married and you bought your home in 1989 for $100,000. Now, it’s worth $700,000 and you’re ready to cash out. You pocket $600,000 and only pay a capital gains tax of 15% on $100,000 – or $15,000. Your total gain is $600,000 but you exclude $500,000…remember? That’s a spicy meatball if you ask me.
There are a few rules, and you can use these to your advantage – especially if you own more than one property.
You can only exclude the $250,000 or $500,000 on your principal residence. Also, you have to own your home and have lived in it for two out of the last five years before you sell it. But remember, there are no age limitations and you can take advantage of this tax break as often as you like (but you do have to wait two years between each transaction).
How do you use this?
Assume you have a residence in Los Angeles and a vacation home in Palm Springs. Sell the residence in LA and pocket the $500,000 gain tax-free. Then, move into your vacation home in the desert. Stay there for two years and then sell it. At that point, you can earn another $500,000 tax-free gain.
Another way to take advantage of this rule (and the fact that real estate prices are low and mortgage rates are cheap) is to simply start buying real estate. Get that five-year clock ticking. Now is a good time to buy a house, my friend.
Of course, you want to buy right. You need to know how much house you can afford and where to buy it. But given the current economics and tax break, I believe you can take this opportunity to create significant wealth for yourself right now.