The home sale income tax exclusion and asset protection


Asset protection is not about hiding your wealth from the IRS to avoid paying taxes. However, a comprehensive asset protection plan takes into account all legal avenues of protecting your wealth. Sometimes, you can use asset protection in conjunction with tax reduction strategies to maximize your benefits. One example of this is the income tax exclusion for the sale of your home.

Excluding gain from the sale of your primary residence

Ordinarily, when you sell real estate, you have to pay taxes on the gain (profit) from the sale (at the capital gains tax rate). However, there is an exception. Internal Revenue Code Section 121 (IRC 121) allows you to exclude up to $250,000 of gain from the sale of your principal residence. In other words, when you sell your home, you can make a profit of up to $250,000 and not pay taxes on it. If you’re married and filing jointly, this amount jumps to $500,000.

To qualify for the exclusion, you must satisfy the following requirements for at least two of the five years prior to the sale of the home (not necessarily at the same time):

  • Use of the home as your principal residence (if married and filing jointly, this applies to both spouses)
  • Ownership of the home (if married and filing jointly, only one spouse must satisfy this requirement)

This is a powerful tax reduction tool that can be utilized multiple times in your lifetime (every 2 years), saving you thousands or even tens of thousands of dollars in taxes.

What if my home is owned by a business entity, like a LLC?

Here’s where the intersection of asset protection and tax reduction comes into play. Your home is owned by a business entity (or you’re thinking of forming one), but you want to take advantage of the income tax exclusion when you sell.

The Code of Federal Regulations sheds more light on this. 26 CFR 1.121-1(c)(3) allows you to do this if the otherwise eligible business entity:

  • Has a single owner, and
  • Is disregarded for federal tax purposes as a separate entity.

If the entity meets both of these requirements, you’re treated as owning the home for purposes of IRC 121. The sale of the home by the entity is treated as if made by you.

How does marriage affect ownership by a business entity?

An entity that is solely owned by husband and wife as community property may be treated as a disregarded entity for tax purposes. However, trouble may arise with the single owner requirement in this situation.

Depending on your circumstances, and the laws of the state where you reside, you may have a couple of options:

  • One spouse as owner: Only one spouse needs to satisfy the ownership requirement. So one way to structure it might be to form an entity in which one spouse is the sole owner (and disregard it for tax purposes). Assuming both spouses meet the use requirement, they would file jointly and exclude up to $500,000 in gain from the sale.
  • Both spouses as owners: If both spouses wish to share ownership of the home, each spouse might decide to hold their half ownership in their own single member entity. Then, if they each individually satisfy the ownership and use requirements, they would file individually and each exclude up to $250,000 in gain on their individual returns.

The exclusion of gain from the sale of your primary residence is one of the most generous tax breaks the IRS has to offer. What makes it even better is that it can work within your asset protection plan to help get the maximum financial benefit.

Sollertis can help with asset protection

Sollertis has the experience and legal knowledge necessary to help you protect your assets. We want to help you achieve financial freedom and focus on what’s important, instead of worrying about your liability.

If you think we may be the right law firm to help you with asset protection, please contact us to discuss your situation.

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