- Reasoned Reflections
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- Reflection No. 50
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Good morning! Last week we explored mortgages and PITI payments, and this week we're shifting to one of homeownership's biggest tax advantages—the ability to exclude gain when you sell your primary residence. This powerful tax benefit can save you tens of thousands in taxes, but only if you meet specific ownership and use requirements that we'll break down today.
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Three Quick Hits:
Article: Retirement Challenges
Saving for retirement will always come with challenges, and today's Americans are facing some particularly tough ones—inflation eating away at purchasing power, rising everyday costs squeezing budgets, and unpredictable market swings creating uncertainty. But here's what matters most: even small, consistent contributions beat sitting on the sidelines entirely. Remember, time in the market is your greatest ally when building retirement wealth, so don't let today's obstacles prevent you from taking that first step.
Tip: Keep your total mortgage payment (including principal, interest, taxes, and insurance) at or below 25% of your gross monthly income.
Quote: “The purchase of a residence is one of the most significant financial milestones in your life. It provides both monetary prosperity and emotional security.” – Suze Orman
Two Questions:
If you never had to work for money again, what would you do with your time, and how much money would you actually need to fund that lifestyle indefinitely?
What percentage of your discretionary spending is influenced by wanting to keep up with or impress others, and what would happen if you eliminated just half of those expenses?
REFLECTION No. 50: IRC Section 121
I - Issue: Do you have to pay capital gains taxes on the sale of your principal residence?
R - Rule: Under IRC §121, a taxpayer may exclude up to $250,000 of gain from the sale of a principal residence ($500,000 for those that are married, filing jointly) if (a) the property was owned for at least 2 years during the 5-year period ending on the sale date and (ii) the property was used as a primary residence for at least 2 years during that same 5-year window.
A - Analysis: Think of eligibility as a two-gate system: ownership and use. Each requires an aggregate of at least 24 months during the 5-year window, but the months do not need to overlap and can be nonconsecutive. Passing both “gates” allows up to $250,000—or $500,000 for joint filers—of gain to be excluded.
For married couples filing jointly, the $500,000 exclusion applies if at least one spouse meets the ownership test, both spouses satisfy the use test, and neither spouse has claimed the exclusion within the last 2 years.
The last thing you should know is that nonqualified use after you move out of your primary residence doesn't count against you, as long as you still meet the 2 out of the last 5 years test. This creates a valuable planning opportunity: if life circumstances force you to move (job relocation, family changes, etc.), you don't have to rush to sell your home to preserve the tax benefit. You can rent it out for income while still maintaining your exclusion eligibility.
C - Conclusion: The Section 121 exclusion is a powerful tool, allowing many homeowners to sell a primary residence and shelter a substantial portion of gain from tax.