You know that you have up to $500,000 in capital-gain exclusions when you sell your personal residence—but what if your house has more value than that? This time, we’ll talk about how to sell even a pricey residence without having to take a heavy tax “hit.”

The High-Ticket Dilemma

As you know, under Section 121, if you’ve lived in a house for two out of the past five years, you can sell that property and exclude gains up to $500,000 as a married couple filing jointly, and up to $250,000 as a single. But anything over and above that gets taxed as long-term capital gains.

This is the dilemma that faced some clients I had in California, who had a personal residence that would represent $1 million in gain. When they saw a potential of $500,000 more than what they could exclude under Section 121, they asked me, “Clint, how can we sell this property and not pay any tax?”

It’s actually amazingly simple. I told them, “Move out of your house, arrange to rent a home in your new area, and then designate this home as a rental. List it on VRBO. Put it on Airbnb. Show the IRS that that’s the use you intend to make of your property.”

Shifting from Resident to Investor

Doing this brings you some massive savings that kick in at the beginning of a new taxable year. At that point, this property shifts from your personal residence into investment real estate, being held for that purpose rather than as your primary residence. This way you no longer have to be concerned with Section 121; instead, you’re in the realm of a Section 1031 exchange.  And you can do that with investment property.

Let’s Look at That Again.

Here’s a property that was formerly a residence, but now it’s become an investment. We can sell that property and qualify it under Section 1031 so we can exchange all the gain into a new property.

This is precisely what these clients did. They sold the personal residence under Section 1031, after having set it up as an investment and a rental property. Then, they were able to roll that money into a new property, in a different state in which they were currently renting. They paid zero tax, listed it for rent for a little while, and then—get this!—moved into it. Now, this is their new residence, for which they avoided paying tax on half a million dollars’ worth of capital gain. We saved them $100,000 simply by being able to use a 1031 exchange.

Minding the Rules

Keep in mind, they still have some qualifications to meet in order to make this work. They must live in the new property for five years in order to qualify under Section 121 in the future. But that’s a simple matter: live in it for five years, sell it…and once again, they’re able to exclude up to $500,000 in gains on the sale of the property.

In a Similar Spot?

If this dilemma sounds familiar, and you’re foreseeing a gain of over $500,000 in the sale of your personal residence, do what they did: turn it into an investment. Rent it out for a bit, then do a 1031 exchange—or buy an entirely new property that you can, eventually, move into yourselves.  See us at Anderson Business Advisors to learn how. Then, relax—you’re on your way a great new home AND great tax savings, too!