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Right Time to Sell Your Home*

The home is often the largest hard asset people own. The right time to sell your home requires you to consideration several factors.

Job relocation, retirement, or divorce are reasons to sell your home. Unfortunately, these home sales are often forced upon you.

The second reason to sell your home is more strategic. Moving to a larger home or downsizing does not force your hand. You can plan the transition, maximizing your financial benefit, while keeping your taxes at the lowest level allowed by law.

Regardless if you are forced to sell your home or are planning a lifestyle change, there are steps you can take to maximize your financial gain.

The right time to sell your home.
Deciding the right time to sell your home includes many considerations. The goal is to maximize gain and lower taxes.

Forced Sale

Even under forced sale situations, there is a sliding scale you can work on. While divorce may require an immediate sale regardless of financial consequences, other forced sale situations offer options that can add to your net worth and cut your taxes.

Most people are familiar with §121. This is the section of tax code that allows you to exclude up to $250,000 of gain per person on your primary residence if you lived there 2 of the past 5 years.

If you lived in your home less than 2 of the past 5 years you can still exclude a pro-rata share the $250,000 in special situations. The IRS calls these special situations “unforeseen circumstances.” This is a very wide road. Involuntary conversions (your home is taken or force sold outside your control), change in employment, divorce, and even having twins from a pregnancy can allow you the §121 exclusion.

The IRS has been liberal in their interpretation of unforeseen circumstances. Whenever one of these special situations forces a sale of your residence, it is time to sharpen the pencil and decide if you should exclude some or all of the gain on your home sale.

Under unforeseen circumstances you must pro-rate the exclusion. For example, if you lived in your home only 1 of the past 5 years you are allowed to exclude up to $125,000 of the gain per person. (One year is 50% of 2 years (the 2 out of 5 year rule), therefore you get to exclude up to 50% of the $250,000 exclusion, not 50% of the actual gain. In most instances this results in zero tax on the gain since it was such a short-term involved.)

Now let’s turn to forced sales that offer some leeway. A job relocation might mean you have to move. But you don’t really have to sell your current home. You could kick the can down the road by leasing the property. Hiring a property manager takes 99% of the work and hassle out of landlording.

By kicking the can down the road you get a current income stream and some tax benefits, such as depreciation.

The tax benefits can be significant for some higher income taxpayers. Deductions, such as depreciation, are taken against ordinary income. As of this writing, the top federal tax bracket is 37%. However, when you sell the property the depreciation is recaptured at ordinary rates with a cap of 25%. This kiting of the tax brackets is often forgotten when tax planning. (Think about this. You deduct at up to 37% and the most you can pay later is 25%.)

To make the deal even sweeter, you can lease your current home, and when you sell, if you still fall under the 2 out of 5 year rule for §121, you can still exclude up to $250,000 of gain per person. Yes, you must recapture the depreciation taken while leasing the property. But the recapture is taxed at your tax rate, but no more than 25%. (Unforeseen circumstances rules still apply.)

Under a divorce, you should consider the consequences involving your home. Should you or your spouse take the home as part of the settlement? Facts and circumstance will prevail. One thing is certain, fire sales rarely are good for financial wealth.

Illness is a very special situation that requires serious thought and time to work out the optimum financial path. Selling your home will give you a one-time shot in the arm if there is equity in the home above selling costs. But an income stream might be more valuable and avoids selling costs. Property managers really can take the work out of leasing your property. So leasing can be a profitable option.

Whenever faced with a forced, or nearly forced, sale of your property, you must step back and think through all the options. Most situations offer options that can benefit you. Working through the options can provide serious financial benefits. The fire sale is the last, and worst, option.

Staging your home can increase the selling price.
Staging your home can increase the selling price.

The Real Right Time to Sell Your Home

The best time to sell your home is on your terms and time schedule. The time of year can affect the sales price. A hot real estate market or a cooling market will play into your decision.

One thing is certain, when you plan the sale of your home you will always have a better result. Throwing chance to the wind is an awful business model.

Let’s turn to the three most common reason for selling your home: moving up, downsizing, or you reached an age where you would rather rent an apartment so you can travel or at least avoid yard work.

The same strategies above can be applied when you move up, downsize, or rent yourself.

Maybe your family is growing and you need a bigger home. That might qualify as an unforeseen circumstance. But! If the real estate market is in a slump, waiting to sell might be a better option.

All the rules discussed above are still in play. The one massive caveat is §121. It is rare to benefit financially when leaving the exclusion on the table. The tax savings are just too great. If you lease your home, be sure to consider selling before less than 2 of the past 5 years elapses. You can lease the home for a few years, but eventually the 2 out of 5 year window will eclipse.

Another consideration involves some serious tax planning, but has the potential of saving you massive amounts in tax savings.

If you turn your residence into a rental property you can mitigate the work involved by hiring a property manager. But what if the local real estate market is still in the dumps a few years out and you risk losing the §121 exclusion? Holding the property longer does provide an income stream, whereas selling might mean selling at a price significantly below what you could receive when the economy starts growing. What to do?

Losing the §121 exclusion can be a big deal if the gain is large. However, some of the gain will have happened after the property was turned into a rental. If §121 still applies you get a gift from selling, as the gain under the time the property was leased still counts under §121. Only depreciation is recaptured.

If you find yourself in a situation where you have a large gain and selling would mean you leave a lot of that gain on the table, the tax benefits of §121 might not be enough to cover the selling discount if the property is sold now.

We can have our cake and eat it too. We just need to use other sections of tax code.

You might be familiar with the like-kind exchange, sometimes called the §1031 exchange. In a 1031 exchange you sell one investment property and buy another of equal or greater value to avoid tax on the gain.

Well, that is fine and dandy, but I want to sell and get out of real estate! How does a like-kind exchange solve that problem?

It solves the problem because the replacement property on the 1031 exchange is not what you think.

Most people visualize a like-kind exchange involving a property sold and a property purchased. And in most cases that is exactly what happens. You effectively trade this property for that property.

But the like-kind exchange isn’t that rigid. You can sell several properties and replace it with one larger property, or! You can sell one property and replace it with several properties. And as much as you might think we are going in the wrong direction if you want to exit real estate investment properties, in reality this neat little nuance in the tax code is an opportunity of gargantuan size.

The IRS says you can do a like-kind exchange to avoid the tax on the gain by pushing the gain into the new replacement property. And §453 says you can use a DST as a replacement property.

So, what is a DST? Well, a DST actually covers two strategies under one acronym: the Delaware Statutory Trust and the Deferred Sales Trust. Details on these two DSTs is beyond the scope of this article. You can read details here if you find what I say below interesting.

The pertinent details I will cover in this article involve the end results.

Under either DST, you have used the DST as the replacement property in a 1031 exchange. DSTs require a third-party and often times that third-party is a law firm. The law firm generally organized and manages the investment (hires property managers and handles the tax and accounting). You get a K-1. That’s it. No worries about dealing with real estate issues. You get a K-1, enter it on your personal tax return, and enjoy the tax benefits.

The beauty of the DST is the timing of taxes on profits. The Delaware Statutory Trust is usually a longer term investment. There is an income stream along the way. Capital gains are realized when you sell your interest, or part thereof, or when the DST sells a property.

The Deferred Sales Trust has a bit more flexibility in distributions. Long story short, you have greater ability in determining how much of an income stream you want and where it comes from. Until principle is distributed, taxes on gains are deferred. The Deferred Sales Trust looks and feels more like an installment sale, except you don’t have the risks of an installment sale.

Why is this such a sweetheart deal? Because the DST allows you to defer gains until you retire or have a lower taxable income. This means a lower tax bracket. For 2024, long-term capital gains enjoy a 0% tax bracket on joint returns with gains up to $94,050 ($47,025 for singles and $63,000 for heads of household).

Let me clarify how this really works. 1.) You take all your taxable income. 2.) Add the LTCGs and qualified dividends to the top of the pile. 3.) The portion below the threshold (i.e. $94,050 for joint returns) gets the 0% tax rate.

We covered a lot of material here. In each situation, more research is required to match your specific facts and circumstances on when it is the right time to sell your home.

It isn’t as easy as calling a Realtor®. How and when you sell your home can add to your wealth while keeping your taxes low, even $0. Armed with this information you can formulate a plan that gives your the best financial benefits.

It might be a good time to consult with a tax professional when planning all the facets of the strategies on this page. There is no harm in showing the accountant this page either, so they can get an idea where I’m taking this.

The best way to keep your taxes low is with a good team. You are now armed with the tools necessary to accomplish your goal when selling your home.

* I hope you stuck around long enough to read this footnote. This article is one of two. The suggestion to publish on the topic of the right time to sell your home came from SEO software. After I accepted the challenge, the SEO software suggested I allow their AI write the article. It is the previously published article on this blog and can be viewed here. This is the human written article. The AI focused on basics, whereas, I focused on maximizing the selling price, lower taxes, and timing of recognizing the gain. Let me know if you think the human did better than the AI.

JP

Saturday 30th of December 2023

Hey Keith,

I agree that the human generated article was more engaging. I was wondering about a rental property that you move into. We have a rental property that has marinated for 7 years. It make decent regular income but the equity invested at 4% would generate more than the rental amount. I was thinking that the wife and I would move into our rental for 5 years and take advantage of IRS section 121. Any pitfalls that I'm missing?

Thanks JP

Keith Taxguy, EA

Saturday 30th of December 2023

JP, it's a good tax strategy and often used. However, recapture of depreciation is still required. The recapture is taxed at your ordinary rate up to a maximum of 25% (§121(d)(6)).

There is also another limitation due to the Housing Assistance Tax Act of 2008. §121(b)(4) says you can only exclude the gain for periods of qualified use. The rental property period for the property is a nonqualified use.

Example: Let's say you bought the property in question for $200,000. Let's also say there was $50,000 of depreciation during the rental use period.

You rented the property for 7 years and lived there 5. You meet the 2 out of 5 year rule under §121, but you must prorate the gain between primary residence and rental years (qualified vs non-qualified use). Seven of the total of 12 years of owning the property is just over 58%. We will round to an even 58%.

Let's say you sell the property for $600,000. Gains must be treated as pro-rata over the holding period.

You have a $400,000 gain and $50,000 of depreciation to recapture. The depreciation recapture is easy. It is all taxed as ordinary income with a maximum rate of 25%.

The $400,000 gain needs to be pro-rated over the life of ownership. Of the $400,000 gain, 58% applies to the non-qualified use years. $400,000 x .58 = $232,000. The $232,000 is taxed as a long-term capital gain. The remain $168,000 falls under §121 and is below the exclusion maximum of $250,000 ($500,000 on joint returns where both spouses qualify).

Therefore, your tax strategy works, but is not unlimited. Using my example with your facts, we get to exclude $168,000 from income under §121; the $50,000 of recaptured depreciation is taxed at your ordinary rate, up to a max of 25%; and the remaining $232,000 is taxed as a LTCG.

This can get complicated in these situations. Hope my illustration helps.

RichardP

Tuesday 5th of December 2023

The human version is dramatically better. The AI version was simplistic and EXTREMELY repetitive. While reading it, I actually wondered "Did different people write the different sections?"

Keith Taxguy, EA

Tuesday 5th of December 2023

Richard, I think AI just copies from places around the web in building an article so different people did actually write the AI article.. I also agree the AI was simplistic. I am also aware of my shortcomings. The advantage humans have is we have personal stories that color our material. That can be good or bad. But always gives us the edge over AI.

John Bauer

Tuesday 5th of December 2023

Your version beats ai version hands down, ai version was like eating stale bread :)

Kate D

Tuesday 5th of December 2023

The human version wins.

The AI version did a decent job of collating some major trends such that a reader would have a frame through which to think about their decision but I found the information repeating/redundant and rather simple. Maybe for me it was a lot of words that did not add enough value for the time I gave reading it.

Your human article was much more insightful (offered value) and covered many strategies with enough detail to know if the strategies might apply to my situation. Then there was enough detail to get me on my way towards learning more/taking next steps.

Keith Taxguy, EA

Tuesday 5th of December 2023

Kate,

I agree with you on the AI version. It is the main reason I decided to publish this head-to-head. The AI version wasn't bad, it just lacked creativity or any personal touch.

I'm glad my version rose above and beyond the AI. There are a few things I have issues with, but writers can be very picky about their own work. Example: I struggled with my article having the readability found in the AI version. These kinds of issues come and go, depending on the piece. Just part of being a writer.

Reagan

Tuesday 5th of December 2023

I could have written the AI article; I could not have written yours. Humans win, 100%

Keith Taxguy, EA

Tuesday 5th of December 2023

Reagan, I found exactly the opposite because I'm hard wired differently. I try to avoid the bland disposition of information because you can go anywhere to get that. I'm always looking for an angle, and of course, a tax and finance aim.