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Did you know the IRS allows you to keep up to $500,000 in profit tax-free on the appreciation on your home? We may be in the market for a high end home soon and it got me thinking into the tax implications of owning a home. I came up with a couple of scenarios to help illustrate a point.

Scenario 1: Buying a $100,000 home and plan to keep it for 20 years at which point, sell for profit and retire to small condo or overseas.

Assumptions: Home will appreciate 4% (average) over the next 20 years. You are married. (Limit for tax free profit for singles is $250k)

Profit: Doing some Future Value calculations, we discover that a $100,000 home will be worth approximately $603,156 in 20 years assuming 4% appreciation. Since the original purchase price was $100,000 then the profit must be ($603,156-$100,000) = $503,156.00.

Tax Liability: Taxes would be owed on $3,156.00

Scenario 2: Buying a $500,000 home and plan to keep it for 20 years at which point, sell for profit and retire to small condo (or overseas).

Assumptions: Home will appreciate 4% (average) over the next 20 years. You are married.

Profit: Doing FV calculations, we discover that a $500,000 home will be worth $3,015,780 in 20 years assuming 4% annual appreciation. The profit on this home investment ($3,015,782 - $500,000) = $2,515,782. Since 500k is tax free, the tax liability is on $2,015,782.

This level of profit would automatically put you in the highest tax bracket. It is impossible to know what the tax rates will be 20 years from now but at the current rate of 35%, you’d owe $705,523 in taxes. It gets much worse if you die and you get hit with estate taxes (currently at 45%) which means you’d owe $1,132,101.00!

It’s fairly easy to see why so many people gripe about estate taxes. Essentially, the children that would inherit this home would be hard pressed to come up with 700k to 1.1 million in cash to pay taxes on this home. Keep in mind that this was originally a 500k home purchased and kept for 20 years; it isn’t a 3 million dollar home right now!

People buying homes on the east coast and west coast are going to get royally screwed in 20 years or so and it won’t be too amazing to see people extract the equity in their homes and blow the cash. Who the hell would want to pay all that money in taxes?

It would seem to me that the best thing to do is to extract as much home equity, take the cash, buy tax free bonds, write off the loan interest on your taxes and never sell your home or pay off your mortgage.