Here are three different ways to save on your tax bill as a homeowner.
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In 1789, Benjamin Franklin said, “In this world, there is nothing certain except death and taxes.” He said this at a time when there was no income, payroll, or corporate taxes. Go figure! Here are three strategies that our clients use to avoid (not evade) paying taxes when buying and selling real estate:
1. Primary residence exemption. If you’ve lived in your home for two of the last five years, the IRS will allow you to exempt the first $250,000 in capital gains taxes when you sell it. That number goes up to $500,000 if you’re married. I’ve had clients build a small fortune by buying and selling homes every two to four years and avoiding those taxes. You can get creative with this. For example, you could move into your beach property for a few years and sell it using the exemption.
2. 1031 exchange. This is a bit more complicated, and I really advise you to speak with a tax professional before getting too excited. This allows you to take an investment property, sell it, then keep the proceeds with an intermediary. Then within 45 days, you have to identify up to three properties you might buy with the proceeds. Within 180 days of the sale of your investment home, you need to close on one of those properties.. Then you won’t be taxed on the proceeds of the sale, and you can use the full amount to buy your next property.
"Talk with your tax professional before committing to anything."
3. Depreciation. By using depreciation and 1031 exchanges, you can hold an investment property, make money on it, show a loss, then defer the taxes when you sell. The IRS will allow you to depreciate the building portion of your property, but not the land. Let’s say the building portion of a property is $1 million. You’re allowed to depreciate that over seven-and-a-half years. If you’re making $30,000 in cash flow from the property, you can still show a $6,000 loss. Then, you can use a 1031 exchange to kick those tax consequences down the road, rinse, and repeat.
Disclaimer: I will review these strategies with my clients in general terms, but I always tell them to review this with a tax professional because the rules are complicated, they change, and the IRS penalties are severe.
If you have any questions or would like me to refer you to a good tax professional, don’t hesitate to reach out via phone or email. I look forward to hearing from you soon.