Nothing is Certain Except Death and Taxes

Nothing is certain except death and taxes - This famous quote about taxes originated with Benjamin Franklin in 1789.  Over 200 years later, it still rings true.  Nevertheless, although taxes on income and profits can almost never be avoided, there are a few valuable exceptions. 


Renting Your Home


You typically have to pay tax at the ordinary income tax rate on rent you receive.  In addition, in some cases you may need to pay a 3.8% net investment income tax on rental income.  However, you may be able to rent a house, condo or apartment without paying tax. 


First, you must be using the dwelling unit as a home.  You are using it as a home in any tax year if you use it for personal purposes more than the greater of 1) 14 days or 2) 10% of the total days it is rented to others at a fair rental price.  In other words, it does not have to be your primary residence, but it does have to be a home you use for personal use at least the number of days that are required each year. 


Second, you can only rent the home for fewer than 15 days each tax year.  If you rent the home for 15 days or more, all of the rental must be included in your income on your tax return.  For more information on this topic, see the IRS Publication 527 “Residential Rental Property.” 


Selling Your Primary Residence


When you sell your primary residence, you may qualify for a significant tax break.  If you owned the home and used it as your primary residence at least two of the past five years, you can exclude up to $250,000 of gain from taxation ($500,000 for married couples filing jointly).  You can only do this if 1) you have not claimed this exemption for two years prior to the date the current home sale closes, and 2) you didn’t acquire the home through a 1031 exchange during the past five years.  For more information on this tax break, see IRS Publication 523 “Selling Your Home.” 


1031 Exchanges


Finally, if you are disposing of investment property and acquiring like kind property, you can defer paying tax on the gain with a 1031 exchange.  Although the tax is deferred rather than excluded, it allows you to use the money that would otherwise be used to pay taxes and invest that money in replacement property.  In addition, current tax laws provide that upon the investor’s death, there is a “step up in basis” and any tax that was not previously paid is eliminated when the heirs inherit the property.  So even if death is unavoidable, there are a few cases where taxes can be avoided.