Tax Free Profits With Real Estate

Want to make tax free profits from the homes you live in? You can, but to maximize this investment strategy, you'll need to move a lot.

Sell your home for a profit and pay no capital gains tax - then buy another and do the same. That is the essence of this strategy. The law used to be that you could only roll your capital gain into the next home, and take an exemption once in your life, after age 55. This more or less meant that you had to keep buying more expensive homes to avoid the tax on your gain, and then you got a one-time exemption when you were older.

The change in the law was almost a decade ago, but many people have still not understood what it means. As the tax law is now, you are exempt from any tax on the capital gain from the sale of your home - no matter what your age, and you don't have to roll the gain into another home. The only significant limitations are that you have to have lived in the home for at least two years, or for a total of two of the last five years, and you can only take the exemption once every two years.

What does this mean for an investor? Profit potential, without paying taxes on that profit. For a simple example, suppose you move from your $150,000 home, but keep it as a rental, because you want to capitalize on the high appreciation in the area. You can wait almost three years (as long as you lived there for two years before this), and sell it for let's say $200,000, with no tax due on the gain. That changes things, doesn't it.

Tax Free Profits- A Better Example

There was a young man in Arizona who had a simple plan. He bought a home, fixed it up while living in it, and sold it for a profit after two years - paying no taxes on the profit. It worked especially well because he was doing this from the late 90s until recently, when hoe prices were going up at 15% or more per year in his area.

His plan worked so well, in fact, that he didn't need to get a job. He might buy a home in a neighborhood where homes were around $200,000, for example, but buy it as a fixer upper for $140,000. He spent maybe $15,000 bringing it up to the standards of the neighborhood, lived in it for two years while homes in the area appreciated 15% per year, and then sold it for $265,000. His $90,000 profit was tax free.

Even if you include his payments and taxes as an "expense" he had free housing and around $50,000 of income for the two years. As I recall, one home netted him more than $120,000 profit - tax free. As the two-year mark approached, he would start looking for the next home to live in and make a profit on. With no other job, he had a lot of time to find the best deals.

Talk to a tax specialist for more complicated scenarios, but there are undoubtedly other ways to take advantage of the new tax law. If you bought a home as your residence, for example, then moved out and rented it for some years, you may qualify for the exemption by moving back into it for two years before selling. On a $200,000 gain, this could mean paying $80,000 less in taxes for some investors.