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A Home Run

Matt C. White

MY WIFE SARAH AND I recently dusted off our old Scrabble board. We reviewed the rules and were reminded of the Scrabble Bingo—the 50-point bonus awarded to a player who figures out how to play every letter tile from the tray on a single turn.

Neither of us could remember ever achieving the Scrabble Bingo. That wasn’t surprising, we reasoned, because it’s rare for all the stars to align. You’d need the right combination of seven letters, the vision to see the word they can form, and the perfectly accommodating space on the board to play the long word. On top of all that, you’d need to fit with at least one other previously played letter in a crossword-like fashion.

Lo and behold, that very night I did it. I used all seven of my letters to intersect perpendicularly with an open “e” on the board—forming the word “infields” and tacking the 50-point bonus onto my score.

I share this story not because I think you’ll be dazzled by my Scrabble prowess any more than Sarah was, but because I want you to recognize the significance of a tax planning opportunity that may be open to you—with the kind of serendipity that reminds me of the Scrabble Bingo.

The tax break I have in mind is the personal residence gain exclusion. It’s the one that allows a married couple to sell their home and completely wipe out all taxes on a gain of up to $500,000. The exclusion is $250,000 for a single individual. Let me explain how the stars are aligning right now to make this tax benefit more relevant than ever to more people than ever—and how it could deliver a tax bonanza for those looking to move. Here’s the trio of remarkable conditions that are coming together:

  • Home equity is at an all-time high. The real estate data firm ATTOM tracks how many mortgaged U.S. homes have equity-rich owners, meaning they have at least 50% equity in their home. As of the second quarter, 48.1% of homeowners had achieved equity-rich status—the highest percentage ever recorded. How did we get here? A combination of historically low mortgage rates and skyrocketing home prices.

Even though the July median existing-home sales price fell to $403,800 from the record-high June mark of $413,800, July continues an astounding streak of 125 consecutive months of year-over-year price increases—yet another record. More people than ever now own a home with a $500,000 (or $250,000) unrealized gain baked in—enough to realize maximum benefit from the tax exclusion. While it’s true that if you sell high, you’ll likely have to turn around and buy high, homeowners with a lot of equity are in better shape to do so.

  • Many who own that equity are ready to move. In East Tennessee, where I grew up and still live, I now have more new friends who have moved here from out of state than ever before. They’re coming from all over the country for all kinds of reasons: to find a more reasonable cost of living, a more agreeable lifestyle, to be closer to family, closer to nature—you name it.

Some are retiring here, but many have families with school-age kids. Often, remote work has made it possible to move without switching jobs. The Washington Post recently reported that about a third of all work is now done remotely, and this number appears to be holding steady, even as the pandemic wanes. Knowledge industries like finance and information lead the way, but every industry has become more open to remote work, and that’s removed a barrier to many potential moves.

  • Rent prices are at an all-time high. Thanks to climbing mortgage interest rates colliding with already-high home prices, housing affordability has tanked. According to the National Association of Realtors, it’s at its worst level in 33 years. These market conditions have led many would-be homeowners to rent instead of buying, which helped push up the July national median asking rent to $2,032. You guessed it—that’s another record.

Why are rent prices relevant to this conversation? Because, in an unexpected display of generosity, the tax code will count your home as a qualifying primary residence provided you’ve used it as such for any two out of the past five years. That means, once you’ve lived in a home for two years, you could move, collect that record-high rent check for up to three years and still take advantage of the full $250,000 or $500,000 exclusion—as long as you sell your home before the end of the fifth year.

Given that home prices could decline, is it worth it to rent your home for three years before selling? I could quote an economist’s prediction of where the housing market is headed, but would that really matter? The reality: No one knows. If I moved, I might try to rent for three years if the right situation fell into my lap. But if not, I’d happily sell and not look back.

Tacking on three years of rental income to this deal is like getting the 50-point bonus for playing a Scrabble Bingo. It’s a great goal, but successful players won’t let a preoccupation with the bonus deter them from taking the easy points right in front of them. The real key to making the whole deal work: You must have a convincing, non-financial reason to move.

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In other words, please don’t uproot your life to pocket a tax-free $250,000 or $500,000 gain. There are so many more significant considerations to mull over before selling your home. But if you already have a good reason to move, shielding $500,000 from taxes is a fantastic play.

Just make sure you qualify for the personal residence gain exclusion before selling. Generally, there are two straightforward qualifications—the two-year ownership test and the two-year residence test. There can be some tricky nuances, however. Here are five clarifications that might help:

1. Only one spouse has to pass the ownership test. If you’re a married couple aiming to use the exclusion, it’s fine if only one spouse’s name is on the title. You can still qualify.

2. The residence test applies to each spouse separately. Let’s say you got married and decided to buy a new house together, so you both sold your previous houses. You could each qualify to exclude up to $250,000 of gain if you’d lived in your respective homes for two years. But you wouldn’t qualify for the $500,000 exclusion on the sale of either one.

3. If you need to sell before meeting the two-year residence test, you might still qualify for a partial exclusion, but only in limited circumstances. It won’t work if you moved just because you wanted to, but it might work if you can show that you were motivated by a change in work location, a health issue or an unforeseeable event.

4. You can apply the exclusion to only one sale during a two-year period. If your gain is less than the maximum exclusion, you don’t get to carry over the unused exclusion. You shield what gains you can, even if they’re less than the $500,000 maximum, and then you’re done for two years.

5. If you rent the home before selling, don’t forget about depreciation. While you rent, you get the benefit of this tax deduction, which simultaneously reduces your home’s cost basis for tax purposes. But when you sell, you have to pay tax on that part of the gain that’s attributable to the depreciation.

I think about the personal residence gain exclusion now because it can be so valuable. Exactly how much in tax savings is at stake? It depends on your individual tax picture. If you have significant income from other sources, the pertinent tax rate could be 23.8%, which works out to $119,000 of tax savings on a $500,000 capital gain. I recommend finding a trusted tax professional to help you figure out whether you qualify and to make sure you report everything correctly—especially if you rent before selling.

Matt Christopher White is a CPA and CFP® who writes about money and apprenticeship to Jesus. He’s the author of “How to Love Money: Four Paradoxes that Breathe Life into Your Finances,” available at MattChristopherWhite.com. Matt is equally comfortable talking about Luke 6:43, Section 643 of the Internal Revenue Code and the 6-4-3 double play. There’s no place he’d rather be than with Sarah and their two girls, Lydia and Eliza, at their home in the foothills of the Smoky Mountains. Follow Matt on Twitter @WriteMattWhite and check out his earlier articles.

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DrLefty
DrLefty
22 days ago

We sold our home of 21 years in 2019 and moved into a new condo. Our gross profit was a bit over $550K, but with sales costs and improvements, we easily got it under $500K for tax purposes. California also has a property tax law allowing folks 55+ to move and keep their property tax basis from their previous home, which in our case dated back to the late 1990s when things were much more affordable. Buying that house in 1998 turned out to be the best/luckiest financial move we ever made.

Richard Adams
Richard Adams
13 days ago
Reply to  DrLefty

My fellow southpaw makes a good point here – I believe home improvement costs can also be used to reduce the taxable gain above and beyond the $500k exclusion. We are fortunate enough to be sitting on gains well above $500k on the house we bought in 1996, but we have tried to keep good records on the many significant home expansions and improvements we’ve done over the years. Whenever we sell, I guess we’ll see if the IRS agrees that we kept good records on those improvements.

mytimetotravel
mytimetotravel
23 days ago

Unfortunately, the exclusion has never been increased because of inflation. I am single and have owned my house long enough that my gain will exceed the exclusion, even after adding in all improvements.

Nate Allen
Nate Allen
22 days ago
Reply to  mytimetotravel

It would be nice for Congress to address this, up the exclusion, and tack it to inflation so they don’t ever need to worry about it again.

Last edited 22 days ago by Nate Allen

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