The Tax-Free Gain on Sale Exclusion: Can You Sell a Rental Property Tax Free?

How to take advantage of the homeowner’s tax exclusion as a real estate investor.

Elizabeth Carlassare
3-minute read
Episode #24

Today’s topic is how to take advantage of the homeowner’s tax exclusion as a real estate investor.

In the last episode, I talked about the tax break from Uncle Sam that allows you to sell your primary home and pay no capital gains tax on up to $500,000 of gain if you’re married filing jointly and up to $250,000 if you’re single.

Can You Sell a Rental Property Tax Free?

But what about rental properties? Is it possible to apply this tax break to rentals? Unfortunately, the capital gains exclusion does not apply to rental properties. It applies only to your primary home.
But, you can turn a rental house you own into your primary home, and, by doing so, make the sale eligible for the tax exclusion. If it suits you, you can move into your rental house, live in it for two or more years, and then sell it and pay no tax on your gain if it’s under the exclusion limits.

How Can You Make a Rental Property Qualify?

To be eligible for the exclusion, you must own and live in the house for two of the previous five years.

If you own multiple rental houses and are open to an unusual lifestyle, you could repeat the process as frequently as every two years, if you want to sell your properties without paying tax on the gain up to the exclusion limits.

Before you sell a rental property, be sure you’re clear about your reason for selling and be sure that it’s a good reason. Keep in mind that when you sell a house, you’re selling an asset that, over the long-term, typically goes up in value.

Your gain when selling a house that has been rented may be higher than you expect. While you were renting it out, you were most likely depreciating the cost of the house on your Schedule E. When you sell the house, your cost basis in the house is reduced by the amount of depreciation you’ve taken, which makes for a larger gain.

Once again, you may exclude up to $500,000 of the gain if you’re married and file jointly, and up to $250,000 if you’re single, if you’ve owned and lived in the house for two of the previous five years.

If you move into a rental property you acquired through a 1031 tax-deferred exchange, the rule is more stringent. Instead of needing to own and live in the house for two of the previous five years, you must actually own the house for five years and live in it for two of the previous five years to take the exclusion. (I’ll say more about tax-deferred exchanges in a future episode.)

What if you were to buy a fixer upper, renovate it, and sell it at a profit after living in it for at least two years? Could you can take advantage of the tax exclusion in this situation? Yes, you could. If you’re someone who would enjoy or, at least, could deal with living in a fixer upper while you’re doing the fixing up, this exclusion can be a big part of your strategy.

I said it in the last episode, but it’s worth repeating here: there’s no limit to the number of times you may use the exclusion. However, you may use the exclusion no more than once every two years.

Lastly, keep in mind that you don’t need to buy a next house of equal or greater value to take the tax exclusion. Although this was the case before the Taxpayer Relief Act of 1997, it no longer is. You can use this tax exclusion on the gain from the sale of your home whether you’re selling your home to move up, to downscale, or even to cash out and travel around in your RV.

As always, it’s a really smart idea to consult a tax or financial advisor when making strategic financial decisions.


Today, I’m giving away two copies of Selling Real Estate without Paying Taxes by Richard Williamson. This book is filled with strategies for selling your home, second home, or rental properties without paying tax. This week’s winners are Eden B. and Keith in Ithaca, NY. Congratulations, Eden and Keith! Be sure to check your email for instructions.

Cha-ching! That’s all for now, courtesy of Money Girl, your guide to a richer life.

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