Winning The Exclusion Game

INTRODUCTION
Because of booming housing prices in the 80’’s and 90’s Congress passed an addition to the tax code to relieve the taxpayer’s burden. This section of the tax code has become known as The Homesale Exclusion. In it, single taxpayers can exclude $250,000 of gain from their homes, provided they have lived there for two of the past five years. Married taxpayers can exclude up to $500,000 of the gain on the sale of their homes. Without this section of the Tax Code, taxpayers would pay 15% on the profits from the sale of their homes, as the profits would qualify as capital gains. This advisory will explain how to maximize the profit on your home while Uncle Sam stands by and watches.

 

ONE HOUSE

This is the default situation. Every home-owning taxpayer expects to turn a gain when selling their home. As such, they are entitled to exclude 100% of the gain up to $250,000 or $500,000 depending on their marital status. For the average taxpayer, owning and selling one house is an excellent opportunity to make a large amount of tax free money. You do not have to reinvest in a seasonal home. For many taxpayers, selling their homes is a one time transaction.

 

TWO HOUSES

Why stop with the sale of one house, when the law applies equally well to the sale of two homes (tax free)? The rule allowing the tax free exclusion is not a once in a lifetime exclusion like the old home sale exclusion rule. Since a taxpayer must use the dwelling as a primary residence for two of the past five years, that leaves three years to make gains on a second home which you use as personal residence. Middle class taxpayers can engage in this type of investment simply by selling one residence and buying another. More affluent taxpayers can maximize their tax free gains by buying two residences at the same time. Not only does the second home have the benefit of appreciating over the same amount of time as the first home does, the second residence purchased also qualifies for a second home interest deduction under the Internal Revenue Code. In addition to having the home interest deduction, the buyer can also use the home as a vacation home. Vacation homes not only mean going someplace nice, but also free or lightly taxed income if you choose to rent the unit out when you are not using it. In the meantime, if you use it after you sell the first home; you can qualify for the $250,000 or $500,000 exclusion again when you sell the home.

 

THREE HOUSES

This situation is comparable to holding a Royal Flush in Poker. It is the absolute best hand to hold! In this situation, the taxpayer must hold two houses simultaneously and preferable a third, so it is not possible for all taxpayers to qualify. Under this situation, the taxpayer will own three houses simultaneously. The first home will be the most expensive home, as you will deduct interest from the home on your tax return. The second home will be the second most costly. It too can have its interest deducted on your tax return as a second home. The third home will be the least costly as its interest and expenses are not deductible as itemized deductions. However, the homeowner should rent this location to a willing renter while the homeowner is living in the first home. Doing this will generally cover the interest and maintenance expenses on the third home. Once the first home is sold, the second home becomes the primary residence and the third house becomes the vacation home. The entire time, the third home is appreciating in value. You then switch to the “two home” situation, deduct all interest and taxes on both houses and qualify for the “homeowner’s exclusion” again.

 

CONCLUSION

The Home Sale Exclusion is a windfall for those who seek and seize the opportunities it provides. Owning more than one home is a great opportunity to make money and enjoy a vacation home. What is really great is the tax law as it applies to this strategy. If you have the means, home investment is a great opportunity to make tax free money 


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