Thompson & McCarty, P.C. CPA

The Federal and Alabama governments once taxed all gains on the sale of a primary residence. When that was true, they deferred the taxes when the total proceeds from the sale of a home was rolled into the purchase of a new home within 24 months from the date of the sale. The burden of proof that this requirement was met rested with the taxpayer. As of May 6, 1997 you may exclude up to $250,000 of gain on a primary residence provided that you live in the house at least 2 of the previous 5 years. That applies to each person. So, a married couple can exclude up to $500,000 if they meet the primary residence test. This change in tax code eliminates the old deferral method of tax savings. Your tax basis in your current home is not changed by the new law. It is widely known that many people have a much lower tax basis in their residence than what it is currently worth. This tax loop hole can be used every two years. This is the most widely misunderstood tax break I know of. It could be utilized a number of ways to put cash in your bank account.

I am going to share with you several ways that I have personally witnessed people making big profits from this tax break. Example one is a rental property. The client owned the property for approximately 4 years and converted the property to rental property. They had rolled a gain into the property of approximately $12,000 and had a tax basis of $48,000. They rented the property for approximately six years and depreciated the house as required by the IRS. They completely renovated the house and then moved into the house for two years. They sold the house for approximately $110,000. Since they moved into the house for a 2 year period before they sold, the entire gain was tax free because it was less than the $500,000 thresh hold. Depreciation was about $1,750 so the taxpayer basis was $46,250. Total profit on the deal was $63,750. The great news was that is was 100% TAX FREE! Folks, that is true wealth building. Finally, you can do this ever two years. It just doesn't get better that this. It is widely accepted that to build wealth one has to get outside of the tax system. Here is one way to do it legally!

For my second example I want to talk about a project house. The client purchased the house in bad need of renovation. He purchased the house for $24,000. He fixed the house up enough to make it suitable to move in and live. While living in the home he continued to repair and enhance the home. After living in the home for 28 months he put it up for sale and sold it within two weeks for $98,000. It is called sweat equity but let's take a look at what he accomplished. He spent $11,000 in repair cost and paid $24,000 for the house. Total Sales price of $98,000 - $35,000 equals a profit of $63,000. Since the gain was less than $250,000, and he met the primary residence requirement, this too was 100% TAX FREE! He got paid $63,000 for living in the house and repairing it.

My final example was a young couple that did not have young children. They were building their first home and decided that they would do some of the work as they built. He was a carpenter so he was quite capable of doing much of the work and she liked to paint and do the little fixing up kind of stuff. Between framing, finish carpentry and painting they saved almost $30,000 on the build. They had a child shortly after moving in the house and in just under three years they were expecting another child. Well the house was too small so they would have to move up to a larger house. They sold their house for a gain of just over $60,000. The good news is that is was their primary home for more than 24 months and was completely tax free.

These are real examples of scenarios that truly happened. A business acquaintance and I have come up with a number of ways that this tax loop hole can be used. The bottom line is that this is one of the truly great wealth building opportunities for the average wage earner. You can make it work for you too. If you have questions about your taxes contact us.