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Welcome to an exciting deep dive into the smart ways real estate investors can utilize Section 121 of the IRS tax code to purchase personal residences. If you’re looking to save a bundle legally, this blog is for you.
Under Section 121 of the IRS tax code, you can exclude up to $250,000 of capital gains on the sale of your home if you’re single, and up to $500,000 if you’re married and filing jointly. The key requirement is that you must have lived in the property as your primary residence for at least two out of the previous five years.
You might think avoiding taxes is a shady area, but this isn’t loophole exploitation—it’s entirely legal. The IRS allows you to benefit from this rule precisely because it supports homeownership.
Imagine you bought your first home with a traditional loan, aimed to flip it, but ended up living there for two years while fixing it up. Upon selling, you reap the benefits of Section 121, taking home gains tax-free. By repeating this process every few years, you could amass significant liquid capital without facing a tax hit.
If waiting two years to access your capital gains seems too long, consider a cash-out refinance. This method lets you pull equity from the home without selling it, giving you liquid cash to invest elsewhere. Use this capital for other investments, then sell the house tax-free once the two-year period is up.
Pair Section 121 with a 1031 exchange—a method that allows you to defer paying capital gains taxes when you sell investment properties and reinvest the proceeds in similar kinds of property. See how it works:
You have a commercial property that’s about to net you $500,000 in gains. Instead of paying a significant portion in taxes, execute a 1031 exchange to reinvest in a personal residence. Live in this new home for two years, and when the time comes to sell, you pocket up to $500,000 tax-free.
Many seasoned investors have said it’s possible to pair 1031 exchanges and Section 121 to keep their gains tax-free. One investor shared his success story, flipping properties every two years and amassing substantial wealth without the tax burden. Though not every investor will find the same outcome, it’s worth consulting a financial advisor to explore how this could work for you.
Savvy real estate investors can strategically utilize Section 121 of the IRS tax code to maximize their tax savings on personal residences. By understanding and applying the primary residence exclusion rule, they can potentially exclude significant capital gains from taxation. Moreover, by combining Section 121 with a 1031 exchange, investors can defer taxes on investment properties and further enhance their financial growth.
While these strategies can be highly beneficial, it is essential to consult with a financial advisor to ensure compliance and optimize benefits. With careful planning and execution, real estate investors can leverage these tax code provisions to build substantial wealth efficiently and legally.
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