The Perfect Tax Storm

The current economic market demands that consumers look for new and innovative ways to save money. Often times this can be accomplished by leveraging the tax code to your advantage. In fact, the collision of two worlds can create the perfect tax storm and save you more than $37,500 in taxes. But the amount saved can be much more, depending on the value of the underlying property.

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  World one – IRS Tax Code §121 allows a taxpayer to exclude gain realized on the sale of your principal residence, up to $250,000 ($500,000 if married filing jointly). Its easy to apply – just live in your home for at least two of the last five years, and you can exclude the gain on your sale.
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  World two - IRS Tax Code §1031 allows a taxpayer to defer any gain realized on the sale of business or investment property. Here, you have to purchase similar, or “like-kind”, property at the same time you sell your investment property, or shortly thereafter.

How can these two worlds collide? Through perfect timing. By following the IRS’ time frames, you can leverage both of these tax-saving provisions in a single transaction, and have “the best of both worlds”. Provided certain timing requirements are met, a single exchange may qualify for tax gain exclusion under § 121 as well as tax gain deferral under § 1031.

Here’s an example of how to achieve the perfect-tax-storm: Live in your property for at least two of the last five years, and then convert the property to a rental. Use the property as a rental for at least two years before the exchange, renting it out for at least two weeks each year (and not using it yourself for more than that). Upon the sale of this property, you can exclude $250,000 gain (or $500,000 if married and filing jointly), and any additional gain is deferred and rolls into your newly purchased investment property.

The IRS’ recent revenue procedure lays out the specifics, and should be followed closely. If you need to know more, contact an attorney to help guide you through the process so you can save and defer taxes.