
When you sell your home, the IRS allows one major form of capital gains break. It’s called the home sale exclusion, and it allows you to deduct a significant amount of the profit from your home sale to minimize or avoid capital gains taxes. If you’re selling an investment property, you can use the process known as a “like-kind” exchange to lower your tax burden, but this process only applies to investment and rental properties. Here’s what you need to know.
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Home Sale Exclusions
If you’re selling a house, there are two main forms of tax breaks the IRS allows. The first tax break is called a Section 121 (commonly referred to as home sale exclusion), which allows taxpayers to exclude capital gains from the sale of their home. This means that it could only be applied to the primary residence where you live.
The second tax break is called a Section 1031 (also called a like-kind exchange), which allows taxpayers to defer paying capital gains tax on an investment property sale by using the proceeds to buy another similar property.
In 2023, the home sale exclusion his exclusion allows individual taxpayers to exclude up to $250,000 from the sale of their primary home ($500,000 for joint taxpayers).
You should note that taxable capital gains only apply to the amount made on a sale. This means that you first deduct the price you paid for the house, then you 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 on.
As an example, let’s say an individual bought a house for $200,000. Years later the individual sells it for $500,000. The potential capital gains tax on the sale would be $300,000, which is the profit made from the sale. Using the home sale exclusion, the seller could exclude $250,000 of the profit. and consequently owe the remaining $50,000 in capital gains.
To apply for the home sale exclusion your property must pass two tests:
You should note that you can only have one legal primary residence at a time, meaning that you can only apply the home sale exclusion to one sale at a time. The home sale exclusion does not apply to investment or rental properties. This must be a home that you live in and it cannot be a second home.
Taking Advantage of Like-Kind Exchanges

The IRS defines like-kind exchanges as exchanges between real properties that are used for business or held as an investment for another business that is the same type or like-kind.
Generally, when sellers make this type of exchange, they are not required to recognize a gain or loss under Internal Revenue Code Section 1031. This means that if you own business property, the IRS allows you to sell one property and use the proceeds to buy another without having to pay taxes on the transaction.
This once applied to all forms of business assets, however, Congress eliminated like-kind exchanges for all assets in 2017. This tax legislation limited to real estate held for active transactional purposes, such as rental properties, offices, shops, hotels and other in-use assets; and created a dedicated benefit for closely or individually held real estate firms.
Like-kind exchanges must meet three general requirements:
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 from this sale into escrow. You then have 180 days to find and purchase another similarly situated piece of land. This new purchase must also generate income through rentals or other use, and it must also be exclusively for business purposes.
You can then use your escrowed funds to buy this property. If you do so, the IRS allows you to consider this an exchange and you do not have to pay taxes on the proceeds from your original sale.
If you own a rental property and would like to upgrade it, this can be an extremely useful tool. However, it is not valuable for homeowners, as like-kind exchanges specifically do not apply to your private residence.
Bottom Line

You can avoid a significant portion of capital gains taxes through the home sale exclusion, a large tax break that the IRS offers to people who sell their homes. People who own investment property can defer their capital gains by rolling the sale of one property into another. This like-kind exchange does not apply to personal residences, however.
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