Today I want to talk to you about the “Two of Five Rule,” the best way to avoid paying capital gains taxes.
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How can you negate capital gains taxes during the sale of your home? I’ll answer that and draw out an example for you in the video above today.
Let’s say you are going to sell your house for $600,000, but you originally paid $300,000 for it. Your tax will be based on how much profit there is between that spread. The closing costs will be about $50,000 and you can write off any capital improvements you’ve made. As an example, I used $20,000 in capital improvements, which puts your new base at $530,000 after you subtract the closing costs and capital improvements.
From the $300,000 purchase price to the new base of $530,000, that’s a $230,000 spread. That is the amount the IRS will tax. The good news is something we call the “Two of Five Rule.” If you are a single person and you have lived in the house for two out of the last five years, the IRS will allow you to be exempt for up to $250,000 worth of capital gains. So, with our example, you won’t owe a penny of capital gains tax.
Make sure you’ve lived in the home for two out of the last five years.
If you’re a married couple, you get to double that exemption to up to $500,000 as long as you have lived in the house two out of the last five years.
This means if you have lived in your house for a year and 10 months, it’s best not to close until after you have hit that two-year mark. Otherwise, you’ll lose out on the exemption. On the flip side, if you moved out of the house a couple years back and have been renting it, you want to make sure you sell it when you can still say you lived there for two of the last five years.
If you have any more questions or are looking to sell your home, please don’t hesitate to give us a call or send us an email. We look forward to hearing from you!
