Tools and Investment

The average investor may not know the secret of using Sections 121 and 1031 of the Internal Revenue Code to avoid capital gains tax.  If the investor’s principal residence has appreciated in value beyond the $500,000 gain exclusion as prescribed under Section 121 of the IRS code, is he stuck paying taxes on the profits over $500,000?  Not with some advanced planning.

Section 121 allows for the investor to exclude up to $250,000 in gain for a single person, or $500,000 for a married couple, on the sale of a principle residence, providing it has been occupied as such for two of the past five years.

Under IRC Section 1031, the investor can suspend all capital gains taxes by exchanging an income or investment property into another income or investment property of equal or greater value.

How does one switch a principal residence into an income or investment property? The simple solution: Vacate the principal residence and rent it or make it available for rent for at least a year and a day."

There is an IRS ruling that says that a two year holding period is sufficient to qualify a property as being held for income or venture purposes. The IRS hasn't said how much less than two years will qualify. Heaven Investment Corp. recommends a holding period of at least a year and a day, because that time period puts you into both a second tax and calendar year.

When a property is vacated and made available for rent for a minimum of a year and a day, it qualifies as a 1031 property.  The investor should then sell it and exchange it into a new property, which must also qualify as an investment property.  It must be held for income or investment purposes for a year and a day, at which point it can be resided in as the principle residence.  The outcome?  The investor has sold the previous property and successfully moved into his dream home without paying tax on his gains.