One of the great benefits of investing in real estate is the tax advantages that the United States government gives to real estate owners. When you buy rental properties, you are allowed to depreciate the property, which is a major tax benefit. There is also a tax law that allows a homeowner to pay no taxes on the sale of a home if they have lived in it as their personal residence for at least 2 out of the last 5 years, and owned the home for at least 2 years. I am not an accountant, and I am not providing legal advice so here is the exact law from the IRS website.
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For more information on my investing strategy please check out my complete guide to purchasing long-term rentals.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.
How can you pay no taxes selling a house
The most important part of this strategy, is buying a home below market value or a fixer upper as your personal residence. You then repair the home before moving in, or repair the home slowly over the next two years. Once you have lived in the home for two years, sell the home and hopefully make a large profit. Once the home is sold, you purchase another fixer upper or a below market value home. If you lived in the home for at least two years and met the other IRS guidelines, you may pay no taxes on the sale.
You can use the cash you made from the profit of your previous home, as a down payment or buy the next home with as little down as possible, and use the cash you made to invest in rental properties. The best part of this strategy is you pay no taxes on the profit as long as you follow the IRS rules. Try finding another strategy where the IRS lets you make money without paying them a dime, not deferred taxes like retirement plans, but no taxes ever!
Choosing a house to buy and sell tax free
The most difficult part of the strategy is finding the right home to buy, especially for those of us with families. As many of us know, our families don’t always want to move into a house that needs a lot of repairs or maintenance. We also may not have a flexible enough schedule to be able to wait for that great deal, which is also a home we would be happy living in. I knew about this strategy when I bought my first house and completely ignored it for a few reasons. Part of my problem was the market was very strong for sellers, there were not many fixer uppers available and I did not know how to find the great deals like I do now. I was also very young and not as concerned about my future as I should have been.
In many markets we are seeing very strong sellers’ markets with multiple offers and low inventory. However, there are still many opportunities for owner occupied buyers to find good deals. Many banks and HUD offer their foreclosed homes to owner occupied buyers before they offer them to investors. This allows owner occupied buyers a huge advantage, especially with HUD when looking for a home. Here is a link to my owner occupants guide to purchasing HUD homes. This guide details how to find HUD homes, how to bid and strategies for winning the bid. Fannie Mae, Freddie Mac and Wells Fargo also offer owner occupied programs on their REO properties. If you are buying a home for your personal residence you can usually get a mortgage with a 3.5% down payment or less, depending on what loan programs are available in your area.
My article on how to find a great deal for a rental property also applies to finding a personal residence. This is article tells you the best places to find a good deal on a home that will give you a nice profit in two years. My first house was not a great investment and I ended up selling it for less than I bought it for after owning it for 7 years and putting a lot of money into updates and repairs. However, the second house I bought as my personal residence has been a great investment. We bought this house at the foreclosure sale and were lucky to find a house we loved, didn’t need a lot of work and was a great deal. We had to borrow money from my sister and father in law to make it work, but it was well worth it. We are actually buying another house for our personal residence soon and selling our current house. We already have a buyer for our current house and will walk away with over $100,000 profit, after owning it for about 4 years. It is all tax-free money because we have lived here all four years and that money will provide the down payment for our new house.
Selling and buying a new house tax free
Selling a house can be tricky, if you have to sell your current house before you can buy another. If you have to sell your current house to qualify for a loan and purchase a new house, it is called a contingency. Buying a house with a contingency provides a few problems when trying to maximize profits. You have to time the sale of you house and the new purchase perfectly, usually in a two or three day span and sometimes on the same day. Finding a buyer and then finding a great deal that works in that time frame is almost impossible. Another issue with a contingency is most banks will not accept a contingency on their REO properties, and it makes your offer weaker in a competitive market. If a seller has multiple offers on their home, they are going to take the offer that they think will give them the most money, and has the best chance to close. They will choose the offer without a contingency over the offer with the contingency, if the money is similar.
The ideal situation is to buy a new home without selling your current home, and have plenty of time to move and get your current home ready to sell. This is not a reality for many people because they tend to buy the most expensive house they can afford which I advise against. If you are not able to qualify for two homes, the next best choice is to sell your current home and move somewhere temporarily, while you look for another great deal. Once your house sells, you will be able to make offers on HUD homes and REOs which are usually the best deals. If you want to buy a short sale, you almost certainly have to use the double move technique, because there is no set time frame for closing on a short sale until the bank accepts the terms. Many banks will not accept contingencies on short sales either.
Continue the process over and over without paying taxes
This strategy can be used over and over again as many times as you can handle it. It is a great way to gain cash for investing or a down payment on nicer homes every time you buy and sell. It is not easy to do for a variety of reasons and this is why very few people actually utilize this strategy. Many times a spouse or family member does not want to move into a fixer upper, wait for a great deal or have to move every two years. In my case, you may find your dream home that may not be a great deal, but you feel you will not have an opportunity to buy a similar home in the near future or ever again. If you can pull off this strategy a couple of times or even once, the extra money can make a huge difference in your life.
Potential roadblocks for using this tax free strategy
Nothing ever works out exactly as we plan. Sometimes it works out better and other times things don’t go quite as well as we hoped. There are a few things we have no control over that can delay or derail this strategy.
- A significant decrease in values can cause some serious delays and decrease profits significantly. If you bought the house below market value and bought a house you can afford then you should be able to make a small profit if you need to sell or ride out the market until prices improve.
- Selling your home before you have lived there for two years can also decrease the profit potential. If you’re transferred, have a great opportunity you can’t pass up or simply have to get out of the town you are in, you may have to sell early. If you make a profit on the home you may have to pay taxes on that profit, but you are still making money and coming out ahead of where you were before.
- Many people fall in love with their homes and don’t want to move. If this happens to you, there is nothing that says you have to sell your home every two years and buy a new one. If you love your home and it means more to you than the money you would make from selling it, than stay and enjoy it. The nice thing about this strategy is you don’t have to follow it to a tee to make it work. You can stay in your home longer and change the plan as you go to suit your families needs.
This strategy is very simple, but hard to utilize in the real world. No one likes to move every two years, especially if you have to do a double move and stay somewhere temporarily while you find a new house. It can be difficult to convince our families that moving is worth it, especially if the kids have to change schools. It takes money and hard work to fix up a home, and the good deals are not always our idea of the perfect home to live in. If you can manage to pull this off even once, you can make a huge profit and pay fewer taxes. To many people, the extra money can be life changing and allow them to start investing and get ahead in the game.
If you are looking for a way to save money on your taxes in other areas of real estate, please see a good accountant. They will save you much more money than it will cost to consult with them and you will know you are doing it by the book.