Virtually all CPAs, tax attorneys and other tax professionals will bring the Principal Residence Exclusion under Section 121 of the IRC to the attention of their clients at some point in their careers. Likewise, there is an equal probability that tax professionals will suggest that at least one of their clients conduct a tax-deferred exchange under Section 1031.
Both of these sections are among the most financially beneficial provisions of the tax code. Just by themselves, each of these sections has the potential to save taxpayers hundreds of thousands – and even millions, if Section 121 be used repeatedly – of dollars in taxes.
Section 121 refers specifically to personal residences, while Section 1031 refers to real property held for investment or business purposes. Previously, Section 1031 could be applied to personal property held for business or investment, but this application was recently removed with the Tax Cuts & Jobs Act. While these sections are undoubtedly powerful when used separately, when used together in combination they can be even more useful for taxpayers.
Tax professionals of all kinds – Philadelphia CPAs, Los Angeles tax advisors, Albany tax attorneys, and so forth all across the nation – should understand the rules for utilizing these two sections together so that they can better serve their clients and help them maximize their financial condition.
Converting Property Before the Sale
Section 121 allows individual taxpayers to eliminate up to $250,000, and married taxpayers (filing jointly) to eliminate up to $500,000, of gain from the sale of a “principal residence” (or “primary residence”). To qualify as a principal residence, taxpayers must own and reside in the property for at least 2 years out of the most recent 5 year period. These 2 years do not have to run consecutively, and so it’s possible for a taxpayer to reside in a property for 1 year, live elsewhere for 3 years, go back and reside in the property for another year and then sell the property using the benefits of Section 121.