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Your Most Valuable Asset May Also Be Your Best Tax Friend

Have you thought recently about selling your home?  

If so, you might be selling at a pretty good time. The Case-Shiller US National Home Price Index tells us that the average price of homes across the country has gone up more than 104 percent since January of 2012, ten years ago. That really adds up to a lot of gain for some people who live in certain housing markets around the country, especially if they’ve owned their home for the past several years or more.   

But because your home has risen so much in value, you might also be concerned that selling your home will trigger a big tax bill from all that gain. It used to be that if you were under a certain age you had to buy a new home of equal or greater value within a couple of years, or face the tax consequences. But those rules were changed a long time ago. Now, you may be able to keep most – if not all – of the money you get from the sale of your primary residence, thanks to the little-known Section 121 of the Tax Code. 

Section 121 is one of the provisions that came from the Taxpayer Relief Act of 1997, which allows qualified individuals to exclude up to $250,000 of capital gain from the sale of their primary residence, or up to $500,000 of that gain when filing a joint return with a spouse. You can actually keep those gains tax free and you don’t have to buy another home or more expensive one to get this tax-free treatment. 

Of course, like everything else in taxes, you have to follow some rules and meet certain standards in order to take advantage of it. So how do you qualify? 

Qualifying for Taxpayer Relief Act

First and foremost, you have to pass what’s called the “ownership test” AND the “use test.” On the ownership side, you have to have owned the property for at least 2 years – 24 months. On the “use test” side, you must have occupied the home as your primary residence for at least two out of the last five years (or, to be precise, 24 months out of the last 60 months) before you sell it. Using it as a vacation property from time to time won’t cut it. It has to be your “Primary” place of residence to meet the “use” rule. 

And if you own a vacation home or a rental property that you move into and establish it as your primary residence, you will have to “pro-rate” the gain across the different ownership time periods.  Some of the gain will be primary residence gain, eligible for the exclusion, and some of it will be due to the time it was a rental or vacation home and that gain can NOT be excluded. 

In certain instances, you can get a portion of the gain tax free even if you don’t fully meet that 24-month rule, but those are fairly rare exceptions. And by the way – the two years of residency and two years of ownership do not have to be concurrent. So if you rented it from the previous owner for a couple of years before buying it, that can still potentially work to meet the “use” test. 

 Another rule is that you can only use this particular exclusion on one home sale in any 24-month period of time. So as long as you haven’t used the exclusion on another home within two years prior to or after the sale, you may qualify. 

We mentioned earlier that a married couple filing jointly can qualify for an exclusion of up to $500,000 on one home.  In order to do that, though, you have to show that all of the following are true: 

  • You’re married and file a joint return for the year of sale 
  • Either you or your spouse meets the ownership test I described a moment ago 
  • Both you and your spouse meet the aforementioned use test, and
  • During the 2-year period prior to sale, neither of you excluded gain from the sale of another primary residence 

Now remember, just because you can exclude some or all of the gain on the sale doesn’t mean you won’t have to show some accounting for it on your tax return. If your real estate closing agent issued a form 1099S to you, then you’ll need to demonstrate to the IRS on your tax return why you’re excluding that amount. It’s kind of a hassle, but you’re required to do it. So it may save you some time if you can prove to your agent – with all the proper documentation – that you don’t owe taxes on the gain, so they don’t send you a 1099S.   

Either way, given the fact that for many taxpayers their residence is often their most valuable asset, this is one of the best tax breaks out there. So if you qualify and you’ve decided to sell your home, it’s a good idea to take advantage.   

This is all part of the financial planning process, something we advise our clients on all the time at Lucia Capital Group. How can we help you the most?  Just give us a call! 

Important Information:

The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

No client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group or from any other investment professional.

Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.

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