The Capital Gains Exemption House Flipping Plan

By Steve Gillman

If you know much about real estate at all, you probably know that you can claim a capital gains exemption on the sale of your home (also called the "primary residence exclusion"). There is a way to use this to boost your real estate investing profits, provided you are willing to move every couple years. And although this current slump (I'm writing this in December of 2010) might not be the best time to try the following strategy, real estate prices will rise again. Or perhaps this is a good time, given the deals on foreclosed homes out there and the fact that you have to hold a property for two years in any case to cash in with this strategy.

In the past you could only take the capital gains exemption on the profit from your home once in your lifetime, although you could roll the gain into a home with a higher price than the one you sold. That changed a while back, and now you are allowed to pay no taxes on the first $250,000 of capital gain ($500,000 for a couple) on any house you lived in for two of the last five years before the sale. Ask a tax expert for the details if you are uncertain whether you qualify (you can get a partial exemption if you are forced to move in under two years for certain reasons, for example). But basically, you can buy a home for $100,000, sell it for $250,000 in two years and owe nothing in taxes.

Now, to do this as an investment strategy, you will want to get the best deal on a foreclosed or otherwise distressed property that needs some work, and fix it up prior to selling it two years later. You have to live in the home during that time, so you will be moving often if you pursue this capital gains exemption strategy as a regular way to make money.

How Much Can You Make?

What you can make will, of course, depend on where you try this, what happens to the real estate market, and how well you buy, choose and execute the right repairs and improvements, and sell. A few years ago I read an article about a young man who was buying a home with problems every two years and selling it for a $100,000 profit after fixing it up while living in it. He didn't need a job. But this was while prices were going up, so the gains were largely from appreciation in real estate in general, not just from his smart shopping and work on the homes.

There are two ways to do this too. You can plan to use those two years to do whatever work the home needs by yourself, or you can hire others to fix it up. I would prefer the latter, but if you have the time you are bound to make more doing the work yourself. Whatever you make, it will be more than you can make on a similar home that you don't live in, because of the tax exemption.

Ways to Make More | Related Opportunities | Tips

You can turn a rental property gain into a non-taxable profit as well, if you are willing to make a rented property into your primary residence for two years before selling it. How much of a difference would that make? Well, since state taxes are often based on your reported income on your federal tax return, you can save paying both (check with a tax expert to verify this is true where you live). If you're marginal rate between state and federal taxes for capital gains is 20% and you have a home rented out that has an adjusted cost basis of $60,000 (remember that your cost basis is adjusted downward as you take depreciation), and you sell it for $160,000, not paying taxes would net you an extra $32,000.

If you own several nice homes that are rentals, all worth substantially more than you paid, and you want to unload them prior to retirement, you might live in each for two years and sell them off one at a time in this way. It would take you at least ten years to sell five homes in this way, but it could mean an extra $150,000 at retirement.

Qualifications / Requirements

As mentioned, you have to live in the home at least two of the five years prior to sale, and you can exclude up to $250,000 of the gain from taxes ($500,000 for a couple). For more complicated cases, see a tax expert.

First Steps

Sell your home if you are sitting on a profit, and look for an opportunity to make money on another one after living there two years.

Resources

http://www.realisticflipping.com - Some excerpts from a book about flipping houses.

http://www.flipitrealestate.com - A blog about buying and selling houses.

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