When you sell your home, the IRS allows one major form of capital gains tax break: The home sale exclusion.

This could allow you to deduct a significant amount of the profit from your home sale to help minimize or potentially avoid capital gains taxes. There are two ways to approach this: one for homeowners and one for investment property owners

Section 121: The Home Sale Exclusion (for homeowners)

This allows taxpayers to potentially exclude capital gains from the sale of their primary residence.

In 2024, this exclusion allows individual taxpayers to exclude up to $250,000 from the sale of their primary home ($500,000 for joint taxpayers).

Section 1031: The Like-Kind Exchange (for investment property owners)

This allows taxpayers to potentially defer paying capital gains tax on an investment property sale by using the proceeds to buy another similar property.

Taxable capital gains may only apply to the amount made on a sale. This means you could hypothetically first deduct the price you paid for the home, then remove any tax-deductible improvements or expenses.

Then, you deduct the home sale exclusion. Whatever is left is the amount on which you owe taxes.

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Generally, when sellers make this type of exchange, they are not required to recognize a gain or loss under Internal Revenue Code Section 1031.

Like-kind exchanges must meet three general requirements:

• This property must be held as an investment asset. It cannot be a home for personal use. Generally, if you ever stay at this property it will probably not count for a 1031-like-kind exchange.
• This property must generate income through rental or other uses. You cannot hold the property just as an investment for a later sale.
• The property you buy must be of the same “character and class” as the property sold. This is generally a low requirement, as the IRS considers most real estate fungible for this purpose.

You do not need to make a direct swap in a like-kind exchange. Instead, once you sell your first investment property, you can put the proceeds into escrow and then have 180 days to find and purchase another similar piece of property. This new purchase must also generate income through rentals or other use, and also be exclusively for business purposes.

You could then potentially use your escrowed funds to buy this property. If you do so, the IRS may allow you to consider this an exchange and you may not have to pay taxes on the proceeds from your original sale.

If you’re looking for ways to decrease your tax burden on home or investment property sale, we recommend speaking with a financial advisor. It’s possible they can help you understand your options and look for ways to save money on your tax bill.

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