Ep. 37 | Earn up to $500k Tax-Free: Exploring Lucrative Opportunities
Download MP3Welcome to the Teaching Tax Flow podcast, where the goal is to empower and educate you to legally and ethically minimize taxes paid over your lifetime.
Speaker 2:Hey, everybody. Thank you for joining us back here on Teaching Tax Flow, the podcast. Looking down the aisle of should I say listening to looking down the aisle of works too. Looking down the aisle at episode 37. Today, we're gonna talk about how to earn $500,000 tax free.
Speaker 2:So, no more details. No more hints. We're gonna jump into the show here in a minute. Me and Chris are gonna have a great discussion on this topic. Hopefully, your ears are perked just a little bit.
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Speaker 2:Hey, everybody. Welcome back to Teaching Tax Flow, the podcast. If you can read at all, obviously, you've seen the title of this show. It's earn or I should say earning up to $500,000 a year tax free. Now that's we're gonna talk about earning it.
Speaker 2:We're not gonna tell you how to earn it exactly. But before we do that, I'm John Trubalski. If you haven't heard my voice before, congratulations. Now you can. But even better than that, I have Chris Chris Pacquero with me again.
Speaker 2:How's it going, buddy?
Speaker 4:I am great. Always fun to be on the show. If they haven't heard your voice, John, that means they need to go back to episode one and start from scratch here at the teaching tax flow podcast. And if you enter our voice, welcome
Speaker 2:to your first episode. Right. And if they haven't heard us at all, Chris, you know, I usually don't kick people off of our show. But if you haven't, press the press the stop button right now. Don't listen forward.
Speaker 2:Move on back to one. You got hours and hours and hours and hours and hours of content to listen to. But before we come up with any more corny jokes, drive each other insane, Chris, let's talk about this a little bit. Right? We're not giving these we're not giving anybody a road map to say, you know what?
Speaker 2:This is how you make $500. Go pull couches off the side of the road, sell them on Craigslist, sell them on eBay. We're not gonna we're not gonna tell you how to do it. We're basically gonna tell people how to keep it. So give give us a little bit of a preview on on what we're looking here.
Speaker 4:We talk in teaching tax flow a lot about diagnosing and prescribing different tax strategies and legally and ethically reducing the tax you pay in your lifetime. There are some tax loopholes out there, that enable taxpayers to earn money tax free. One of the three laws of teaching tax flow are is that tax agencies are your involuntary business partner. Tax rules are written to encourage and discourage certain behavior. And one of the tax laws that were written, which we refer to as section one twenty one, allows you to exclude up to $500,000 if you're married filing jointly of capital gain when you sell your primary residence.
Speaker 4:We're gonna dive into some of those rules coming up here, but what's important to understand, first of all, is why do we have this rule? Well, we have this rule because spoiler alert, one of the qualifications is that it, a a property has to be your primary residence for two of the last five years to qualify. Okay? John, let me ask you a question. I know I I'm sure you got all a's in social studies growing up in American history.
Speaker 4:Of course. Of course. What is the term for someone that is elected in the house of representatives to The United States?
Speaker 2:You know what? You would ask me a question like that. It's like you looked into my brain and said, you know what, idiot? You really don't remember a whole lot from that class. So, whatever.
Speaker 2:You answer it. You're smarter than me. I hang out with better looking, smarter people.
Speaker 4:Well, I don't know about that. I I would say your family has but it's a two year Yeah.
Speaker 2:Right? Okay. So so a
Speaker 4:congressperson could win win their congressional district. They can go to DC. They can buy or Virginia or wherever. They could buy a property. They could live in it for two years.
Speaker 4:They could lose their, election the next time coming up, and they could sell their property. And guess what? They could walk away with if they're married, joint, $500,000 of profit, or unmarried, two hundred and fifty thousand dollars of profit. So it's kind of a nice going away gift for someone at the house of representatives. Well, guess what?
Speaker 4:There's a lot of people that do that, in their own personal lives. So section one twenty one of our tax code, again, allows taxpayers, and we're gonna talk about eligibility, to sell their primary residence. Now they do not have to buy another residence. Previously, back in John, when I first started practicing when I had a hairdo over twenty years ago, you used to have to buy another residence for up to that value. You don't have to do that.
Speaker 4:You can you don't have to you can go rent a place. You can go live on a dinghy for all in in T West. I mean,
Speaker 2:back when back when you started, I mean, that was a while ago. Where, was Coke sold in glass bottles and there was cigarette and pull machines at the, at the bars?
Speaker 4:No. But, Moby Dick was a minnow. It's that long.
Speaker 2:Oh, there we go. Okay. You you made you you know, you you always open up the can of worms as or I should say the the head of hair jokes, so we we, you know, obviously
Speaker 4:We need one ball joke at least, and don't worry. We'll loop pickleball into the start of that podcast just to get under your skin. Hey. You know what?
Speaker 2:Just just like your just like your your process, you know, with tax forms, I mean, you're you're pretty aerodynamic. You're pretty streamlined. So
Speaker 4:I am. We are efficient. So what we talk about is in the teaching tax flow world in our community, goal diagnosis. So if you're in a 30% marginal tax rate, $400,000 of taxable income would cost you a hundred hundred and $20,000 of tax. But if it's tax free, goal diagnosis like the section one twenty one exclusion is, it would cost you nothing.
Speaker 4:Now when we talk on this podcast, we're gonna focus on the tax part of this decision. A lot of components come in, to play when you're deciding to sell a property, buy another property, move, downsize, etcetera, etcetera. But so we're gonna just keep this down to, you know, what what are the eligibility issues, where can we find this information on the IRS, websites, and we're gonna link all that to our show notes and some other considerations. And as we jump into these two, Chris, before you we start giving some, you know, little deeper dive explanations, a moment ago
Speaker 2:too, you mentioned loophole. Right? So if anybody is not familiar with with that term, it's not let's not, I should say correlate or associate loophole with sketchiness. Right? So taking advantage of these loopholes is not an unethical practice.
Speaker 2:It's not, you know, kinda skirt the rules. It's there. It's there with intent. It's actually if I'm not mistaken, they're all outlined really in a sense by the IRS is just the fact of actually following through with that. Correct?
Speaker 4:Yes. And I would say there are a lot of interested parties in this section one twenty one exclusion. Not only the congress people, but also, or how people in the house of representatives, the Mortgage Bankers Association, the Association of Realtors, the so there think about whenever there's a house bought or sold, there are several people that are compensated, and there's money put into local economies. So it's not that this is just a zero sum gain. You know, every transaction you have an you would have an inspector.
Speaker 4:You would have an appraiser if you have a mortgage. There are a lot of pluses within a local economy whenever one of these transactions is takes place. That's fine. That's kind of, some some kind of, you know, if you throw a rock in the water, you see all those little ripples. There's a lot of ripple effect of of having this tax law.
Speaker 4:And it allows people, quite frankly, to to take whatever proceeds they have from the house they sold and move that into another property if they so choose. But, again, you don't have to buy another property to take advantage of section one twenty one exclusion. So for for those listening, obviously, don't pull this up on your in your vehicle, if you're driving, but what you're really we're gonna really focus on are the contents of publication five twenty three, put out by the IRS. Now, again, this is this is not, Nobel Peace Prize winning, literature here. But I wanna talk with some of
Speaker 2:the eligibility. You know, you would you would probably use it as bathroom reading. Right? I mean, you I'm sure you print off, flip through it. Right?
Speaker 2:You might be the
Speaker 4:only one, but somebody. Well, you know, maybe. I
Speaker 2:I That that's the most that's the most subtle yeah. Okay.
Speaker 4:I got a couple copies I've ever heard. You know, now we fiddle around on our phones. I don't know what we do. But, anyway, so eligibility tests. So, ultimately, there are there are a handful of eligibility tests to determine if you if you sold your property, would you be able, or your primary residence, be able to walk away with tax free income?
Speaker 4:Alright? We get this question a lot on the teaching tax flow podcast as well. So the personal eligibility is you could there is an automatic disqualification if you acquired this property through a ten thirty one exchange or like kind exchange. We talk about that a lot in in our defeating taxes, face private Facebook community, defeatingtaxes.com, definitely book market, or, in in prior podcast. Also, if you're subject to an expatriate tax, you are automatically disqualified.
Speaker 4:What that means is that someone that has that has left the country, you know, again, we don't wanna dive in the weeds too much with someone that has that is decided to take residency, and citizenship elsewhere. Second step, you actually have to own the property. Right? Just because it's your primary residence, doesn't mean that you automatically beat that two out of five last five year requirement. So, John, let's say you rented a property for several years.
Speaker 4:You bought it after renting it, and then you only owned it for one year, yet you live there for three. You have to have ownership in the property for at least twenty four months out of the last five years leading up to the date of sale. Now it doesn't have to be twenty four months straight. It just has to be twenty four months in that window. In this, a lot of times when you have snowbirds or you have people in you know, living in two different places, this could really play a role.
Speaker 4:So that's the that's the second step. The third eligibility is really step is residence. You know, you you've got to determine if you met the residence requirement. Are you there once in a while? Many people have second properties, a beach house.
Speaker 4:How do you prove residency? Again, it's a facts and circumstances situation, but do you have your voter's registration card there? Do you have your driver's license? Are your vehicles registered there? You know, nowadays, one of the tests would be, well, do you bank somewhere?
Speaker 4:Well, many of these banks are in several states. But, you know, if you owned the home and used it as your residence for at least twenty four months of the previous five years, you're meeting that residence requirement. But that that twenty four month period, like I said, it could it could vary. It could vary. It doesn't have to be continuous.
Speaker 4:And, you know, there are some special there are some special rules. Again, we're not gonna dive into too many too many of the special rules, but some considerations would be if you if you're away from the home for a for a long period of time, like a vacation or a short absence really isn't going to play a big role, but what if you leave for six months and and run around in an RV? I mean, that's that's a consideration. Another consideration is what happens, you know, what what happens if you become physically or mentally unable to take care of yourself and you have to leave the home or go to the hospital? So again, those are those always play a role in that residency eligibility, test.
Speaker 4:You know, the fourth one, so you do get a certain amount of you you know, we love monopoly on the teaching to actual podcast. You get a certain amount of get out of jail free cards. As you said, John, this isn't this doesn't imply that you're gonna go to jail if you use this, but, you don't get an unlimited amount of section one twenty one exclusions. Because in theory, you could have two homes that you both lived in two of the last five years and sell them in the same year. So there's a look back eligibility, and you have to meet the look back requirement.
Speaker 4:So if you didn't sell another home during the two year period before the date of your sale, you meet the look back requirement. Well, so so, basically, you've you've got that two year window that if you have multiple property this would only play a role as if you had multiple properties and you lived in both of them for two years, which, John, I know you live up in Michigan. There are a lot of people in Michigan that spend five months down south and seven months in Michigan. Those are what we call smart people. Get out of here when it's cold.
Speaker 4:Exactly. And and and that's so so that's where you could again, you could realistically have two houses that you meet the eligibility requirement for. The fifth eligibility step is do you meet one of the exceptions? So let's say you fail one of the first four. If you fail one of the first four, you you might meet what's called one of the exceptions, and that's where it's really a facts and circumstance sense of situation.
Speaker 4:We always talk about in teaching tax flow, don't let the tax tail wag the dog. We also wanna know the tax ramifications of your decisions. So, you know, did a separation or divorce occur when you're in the home? Did a spouse pass away? Was your home destroyed or condemned?
Speaker 4:I mean, we've had situations where a home was burnt down, but the taxpayer wasn't there for the full two years, or there was, an eminent domain case where, a bridge was being built and the home was basically taken by, the government because eminent domain. So there's a lot of, you know, especially if you were a service member, there are some special rules. So there are some exceptions to the eligibility test to be considered that maybe you might meet one of those. The most common would be the separated or divorced taxpayers or unfortunately, a widowed taxpayer. So
Speaker 2:So basically, like a you get a bonus point.
Speaker 4:If Yeah. If if you fail, I guess it's a yeah. It's a retake. Right? If you fail the one of the eligibility tests yet you meet an exception, then you're you're back in business.
Speaker 4:And then there's other there are there's other considerations of there's there's circumstances where you could be a getting a partial, exception. Excuse me. Exclusion of Capital Gate. Those things occur sometimes if you rented out the property for a portion for a certain period of time, and then you lived in it for a certain period of time. So it's not it's not always that, hey.
Speaker 4:I get the entire exclusion or none. Sometimes it's partial. Mhmm.
Speaker 2:So a lot of these may may apply to somebody who, say, takes a a six month out of state contract for employment, moves back, but, obviously, over that twenty four month period of time, they've spent the majority of their time there at their primary. It's nice.
Speaker 4:What if they would have rented that primary out for a certain period of time? Exactly. And, hopefully, they don't come back and it's condemned,
Speaker 2:you know, because they don't made and they got a divorce and be they've there's a lot
Speaker 4:of boxes you can get creative and check. But We're seeing that a lot with interest rates. So sometimes taxpayers are locked in a very low interest rate with the property. They don't necessarily need the cash out of it to move, and they wanna create some, some some cash flow for themselves. Now, again, they're they're converting a primary residence to a rental is a serious consideration with some negative tax consequences to be considered.
Speaker 4:So definitely talk to us here at Teaching Tax Flow or your tax professional about that before you make that decision. We're not gonna jump into the basis you know, we're not gonna set jump into that in this podcast, but it's something to consider. When we're talking about the partial exclusion, obviously, if you rented the property out versus utilized it on your own, that could that could be a partial exclusion situation. If you had to move that and it was really work related, that could give you a partial exclusion. So let's say you didn't live in the property for two years, it's a newer property, but there's a work related move, there's a health related move, or some type of unforeseen circumstances we talked about.
Speaker 4:You know, it's funny as it sounds. If you lived in a home for a year and a half, let's say, taxpayer becomes pregnant, it's a it's a starter home, it's a two bedroom property, and taxpayer has triplets. That actually could be an unforeseeable event unforeseeable event that allows them to take a partial exclusion. That's an interesting one. Yeah.
Speaker 4:It is. I mean, though, so we've seen these things happen. One thing though, when we talk about a gain, a cap because when you sell your property, assuming you sold it for more than you paid for it, you have a capital gain. One thing to consider though is that with the one of the concepts is tax flow versus cash flow. The money you receive at closing is not your gain.
Speaker 4:Right?
Speaker 2:They're not gonna do And explain that in a little bit more detail for those that aren't familiar how everything is with that. Because
Speaker 4:that's a
Speaker 2:that's a very important concept that you mentioned that we talk about a lot. Right? Tax flow versus cash flow over cash flow versus tax flow. So let's chat
Speaker 4:on this. So let's talk you walk through, and then I really rounded example of let's say you bought a property for $600,000, and let's say you were fortunate enough to pay cash for it, and let's say you sell it four years later and you're married, joint, for a million dollars. And let's say you have closing costs of $50,000 and you put $50,000 into the property. Okay? So your gain is $300,000.
Speaker 4:A million dollars minus $50,000 of closing cost is $9.50. Your basis for that property, basis is your cost basis, what you paid for it, is the $600,000 you paid for it, and you put $50,000 of improvements. You have a $300,000 gain, assuming you meet all the exception, all the eligibility requirements. You walk away with a $300,000 gain, but at the closing table, you don't have a mortgage. You sold it for a hundred a million $50,000 of of, closing cost, you actually walk away with $950,000.
Speaker 4:We've seen people come into the defeating taxes community, teaching tax flow community say, oh my gosh. I just got I just sold my primary residence. I have $950,000 of closing, and that's over that $500,000 I'm gonna owe a bunch of tax. No. It's it that that's not the case.
Speaker 4:That what you get at closing really is more of a a a result of if you had a mortgage note on the property, and that sort of stuff. The other thing to consider is we talk about cost basis for these properties, these primary residences. It's not just what you pay for the property. A lot of times, especially with new construction, you might have landscaping costs. You might have built a fence.
Speaker 4:You might have some capitalized improvements, or even if you bought an existing residence that needed some work. All of that really plays a role into the basis. And we're talking in a federal level. Final thing I wanna talk about just from considerations, each state is different. Most states comply to the federal section one twenty one exclusion, But those are those are considerations, and and that's why when people say, well, should I keep all my receipts?
Speaker 4:Yeah. We don't need run loads of receipts, but, but at least keep a log with these major home improvements.
Speaker 2:It it's funny that you mentioned saving receipts. Right? I I feel like I just heard a story from somebody. Might have been a friend of mine or or something over one of the past holidays, and they said, oh, I kept all my receipts, you know, for for x number of years, and I felt really confident. And then they go to open it up, and it was all thermal paper, I believe.
Speaker 2:So one had everything on it. They open it up, and they're all blank. Oh. Like, so so so, basically, you got a bunch of a bunch of ribbon tape with nothing on it. It'll it's all black.
Speaker 2:But, Chris, kinda circling back, you know, just one more time a little bit to our title of this. Right? So earning up to $500,000 tax free. Again, we're not we're not telling people how to make 500 k. We're telling you how to basically keep it.
Speaker 2:So the that example of using, you know, defining what capital gains is, obviously, is very important. And really defining on or or breaking down, I should say, how you get to that that total is very important. So if, you know, they make a rewind button for a purpose, go back. It'll listen to that if you're still confused. Exactly.
Speaker 2:So think about this. Here are here are here are
Speaker 4:our action items. One, understanding that the money you get at closing is not your capital gain, and you need to figure out what your cost basis is. Your cost basis could also include a step up in cost basis. Meaning, if if you're a widowed or if you if you inherited the property that lived at it, we don't wanna go on a tangent about cost basis, but understanding that your your your capital gain is based on your sale price minus expenses and your cost basis. The section one twenty one exclusion, there are certain, eligibility requirements that most people meet if it's just their primary residence, If you've had mixed use or have a extenuating circumstance to that create caused you to move, you might be eligible for a partial.
Speaker 4:How do you who is eligible for that up to $500,000, of of maximum exclusion? If you're married jointly or if you're widowed and you sell the home within two years of the death of your spouse and you haven't remarried since then, and you didn't sell any other primary residence. Single or unmarried folks, they still get an exclusion, but it's up to $250,000. Finally, there is a chance if a property had some mixed use like rental, there's still a partial exclusion available. The key takeaway is understand that before you sell a primary residence, really talk to your tax professional and determine the tax consequences of that decision.
Speaker 4:And remember now with current law, you don't have to go and buy another property to complete the exclusion.
Speaker 2:Awesome. Well, that's that's a good good jump into the detail, Chris, as you had mentioned before too. There's a lot more detail in each section of that that we could dive into, but that's probably the best. In all the years I've known you, that's probably the best explanation that you've given even me just chatting with you about it on on how all this works too. So and things change.
Speaker 2:Obviously, every year, there there could be amendments, adjustments to tax law. But is this something that's kind of been in play for a while? Have you seen a lot of changes with this or just some small stuff here and there?
Speaker 4:The biggest change was quite a while ago is when when you didn't have to reinvest in into another property. Obviously, you know, tax we've got, elections coming up here, and, we just we carefully watch, you know, who's running for what office. It would be this would be a major change a major change for this to shift. There's always talk about, let's put this in my professional opinion. I don't see the exclusion changing except for maybe capping it at a certain amount of you know, someone over a certain amount of income can't take it.
Speaker 4:But remember the people at play, tax laws are in to incur to discourage certain behavior. You don't wanna do something that's gonna hurt your friends at the house of representatives. You probably don't wanna you know, in general, politically, there it's probably it'd be tough to change this law because of the realtors, the mortgage folks, the bankers, all the all the industries, big industries that are involved in this type of transaction. So the positive verbal effect. It's the big verbal effect.
Speaker 4:Yeah. Awesome. Awesome. Well, as always, if anybody has any questions related to this, which which you
Speaker 2:may, and and we welcome those, feel free to shoot it over to us in that defeating taxes private Facebook group. As I always say, here's your invite. Can't say we didn't tell you or invite you. So hop on into that as well as if you if you prefer an email directly to our team, always feel free to reach out at hello@teachingtaxflow.com. And, Chris, I know we talked a lot about unfortunate or unforeseen events.
Speaker 2:You guys seen it coming. This is the end of the show. So I know it's very unfortunate, but we will see you next week. Hey, everybody. John Still here from the Teaching Tax Flow team.
Speaker 2:Couldn't get rid of me that easy. Although, would you really want to? Right? You wouldn't wanna get rid of us. We're here giving you tips.
Speaker 2:So all joking aside, what do you think about this past episode here that we did? The past, what, fifteen, twenty minutes or so? Talking about earning up to 500,000, 5 hundred ks a year tax free. Right? So, looking at it from the lens of, you know, your parents or your grandparents, maybe you've used to tell you, Hey, a penny saved is a penny earned.
Speaker 2:So basically, what we're telling you here is how to make more money technically. Not telling you how to earn it exactly, but we're telling you how to keep it. We're giving you tips on how you can keep that income that you know you work so so hard for. So hopefully, you took some notes, got some good ideas, got a good strategy in place or at least the, tip of the iceberg when it comes to that strategy. So, let us know what you thought.
Speaker 2:Drop us a line on our Facebook page, the Defeating Taxes private Facebook group. If you're not a member of that, this is your invite as always. Hop on there. Let us know what you thought. Shoot us an email.
Speaker 2:Give us a call. Shoot us a text. Any way to let us know what you thought about this episode, we want to hear it. If I remember right, this was a topic that was suggested also by a member of that Facebook group too. So great topics.
Speaker 2:Keep them coming. We have even I wanna say two or three really good ones again. I know I always say that, but I feel like we keep getting better and better with these shows, better content, better guests. Got some great ones coming up. If you like this one, almost a guarantee you're gonna love the next ones that are in the pipeline.
Speaker 2:So again, thank you for myself. Thank you from the whole team here at teaching tax flow. Have a great week. Keep on trucking. Bring us those ideas and we will see you soon.
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Speaker 3:Investment advisory services are offered through Cabin Advisors, a registered investment adviser. Securities are offered through Cabin Securities, a registered broker dealer.
