Are you looking for a way to increase your liquid assets? What if there was a relatively painless and tax-free way to add to your investment portfolio without eroding your lifestyle? Would that be something worth investigating? If this interests you and you qualify, read on to learn the secrets of cashing in on real estate.

Perhaps what we will discuss this month really isn’t exactly a secret, but this is the time of year when people are looking to sell their homes and, if you qualify, you might be able to cash in on the gain you have on that home without paying any taxes. Of course, what you do with the proceeds is your business, but if you have significant equity in this home more than what you need, one possibility is to trade this asset for cash that you can invest. Let’s take a look at the possibilities.

Let’s say you have worked hard, put the kids through college, and now want to concentrate on making yourself more comfortable in the future. Take a look at your present home: does it suit your needs now that the kids are on their own? Is now, when the housing market is still pretty good, a time to think about downsizing? The answer to these questions is purely personal, but don’t overlook the possibility of selling your present home, downsizing, and putting the remaining cash into assets that will allow you to do more of what you’d like to do.

Let’s say you don’t really want to raise the value of your investment portfolio, but you do want to (or have to) move. What happens to you if you sell the home for a gain and invest the full amount in a new home? You may just be in luck.

Assuming the market is right for you and you actually do have a gain on your home, how will you get to that money without paying taxes? It’s simple really. As long as you follow the rules, Uncle Sam will to let you keep the gain without taking a share of it for his own.

The Ownership and Use Tests

The tax code is, in many ways, friendly to the homeowner. If you have a property that is, or was, your main personal residence for two of the last five years, you have a potential tax gold mine. That’s because the tax code lets you exclude from income the gain, if any, on the sale of your personal residence, up to a maximum of $250,000 for an individual or $500,000 for a married couple filing jointly. Note that the rule does not require you to actually be residing in the property at the time of the sale, just that it was your personal residence for two of the past five years. The rule also requires that you actually owned the home for at least two years.

If you’re thinking that you have a problem because you converted your previous home into a rental property when you moved into your present home, think again. As long as you meet the ownership and use tests, you may be able to exclude the gain even though you have been living in a new home the last two years. Example: you bought your previous home in June of 2002 and lived in it until July 1, 2004, then moved and put the house up for rent. If you sell the house in September 2006, you will not have to report income on all of the gain you realize. Of course, the gain that’s attributable to any depreciation you took while renting the house is taxable income, but that’s better than paying tax on the whole gain.

Failing to Meet the Ownership or Use Test

These rules are really neat - if you can meet the tests - but what happens if you don’t meet the tests, but you still have a gain in your home? Will you pay tax on the gain? The answer is an unequivocal "not necessarily." Here are the rules that may help you avoid the tax.

If you sell your home for any one of the following reasons, you can exclude some or all of the gain:

1. You sell your home because you move to take a new job, or


2. You have to sell for health reasons, or


3. You sell for other unforeseen circumstances.

There are a number of considerations in determining that the reason for the sale is one of the three reasons above, but this article isn’t meant to delve too deeply into the rules. Suffice it to say that you should never believe you are totally out of luck if you think you can meet one of the three tests. The amount of the gain you can exclude is basically the maximum exclusion ($250,000) prorated based on the time you actually meet the ownership and use tests divided by two years.

Final Thoughts

This article is just an overview designed to introduce you to the possibility of excluding gain on the sale of your personal residence. There are many possible scenarios not discussed, not the least of which involves divorced co-owners. If you are contemplating or have already sold your personal residence at a gain, give us a call. Let’s talk about your options for eliminating or minimizing the taxes on that gain.

Have a great 4th of July and please remember to celebrate safely.