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George Saenz, the Tax Talk columnistHome equity loan doesn't affect sale profits

Dear Tax Talk,
I understand that when selling a home, you are not obligated to pay taxes on up to $500,000 of proceeds assuming the seller is married and has lived in the home for two out of five years prior. However, let's say you have $600,000 equity in your home. A few months prior to selling, you cash out $100,000 in equity by refinancing. Now you are back to having $500,000 in equity. Would this exercise be a possible solution to avoid paying the capital gains taxes on the sale of your home? Thank you in advance. Best regards.
-- John

Dear John,
You're confusing equity with gains. The exclusion of $500,000 for a married couple applies to the gain on the sale of the home and not the proceeds or the equity. Gain is the difference between the selling price of the property and the cost of the property, plus improvements plus buying and selling expenses. The gain does not change by financing or refinancing arrangements.

If you refinance as you suggest, the $100,000 that you pull out is not taxable income. Instead it's a loan. If you use the $100,000 to improve the home, then the improvements are added to your cost. However, if you use it to buy a car or consolidate debts or just put it in the bank, then your cost in the property is not changed. When you later sell the property, your proceeds from the sale will be reduced by the $100,000 that you previously borrowed, but since you already received that money without paying taxes you cannot count it as a cost of the property.

There's no safe bet in trying to shelter gain in excess of $500,000 on the sale of a home. Some people suggest selling it to a relative when you're close to reaching the gain limit of $500,000 and then reacquiring it later. Whether this will fly with the IRS is not yet proven. However, it's probably a safe bet that they won't like it.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.'s corrections policy -- Posted: May 5, 2006
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