The $250,000 / $500,000 tax-free home sale profit rule is a fantastic benefit for homeowners who have lived in their homes for two out of the past five years before selling. The rule is also called the tax-free exclusion rule for real estate.
The tax-free profit exclusion rule essentially says if you are single, you can earn up to $250,000 in tax-free profits. If you are a married couple, you can earn up to $500,000 as a married couple. This tax-free exclusion rule is one of the reasons why real estate is my favorite asset class to build wealth for regular folks.
If you are in a top marginal income tax bracket, then the tax-free home sale profit rule becomes even more valuable. For example, imagine if President Biden raises the highest marginal tax rate to 39.6%. To earn $500,000 in profits after tax, you would need to have a gross profit of roughly $833,000!
The tax-free profit rule seems straight forward. However, there may be some confusion. So let’s clarify using an example!
Clarifying The $250,000 / $500,000 Tax-Free Home Sale Profit Rule
In the post, Buy Real Estate For Capital Appreciation, Rental Income, or Lifestyle, I responded to one reader by mentioning potentially moving back into his rental for two years in order to take advantage of the tax-free profit exclusion. I said they would have to then sell within five years after moving back to get the benefit..
Here’s a great response from reader who is a tax lawyer about earning tax-free capital gains after selling a home. The tax-free exclusion rule has some nuances you should be aware of before moving back into your rental to save on taxes.