The IRS offers a significant tax benefit for selling your primary residence if you have a capital gain. They will exclude up to $250,000 of capital gains excluded from taxation if you’re single, or up to $500,000 if you’re married filing jointly1 (providing you meet the criteria).
This is a generous break that many homeowners rely on to walk away from a sale with more cash in hand. But what if your gains exceed those limits? More importantly, do you have to settle for writing a check to the IRS, or can you defer that tax hit?
If you’re facing a sizable gain, either from years of appreciation in a hot real estate market or from selling a luxury home, then the IRS exclusion may not be enough. Capital gains tax consultants may recommend deferral strategies like Deferred Sales Trusts (DST) to help you defer tax payments and retain more of your wealth. Understanding your options may help you keep even more money in your pocket.
Understanding the IRS Section 121 Exclusion
Section 121 of the Internal Revenue Code gives you the ability to exclude up to $250,000 in capital gains ($500,000 for married couples) when selling your primary residence.2 To qualify, you must have owned and lived in the property for at least two of the last five years before the sale.
This exclusion applies only to your primary residence. If you’ve rented out the home or used it as an investment property, that can reduce or eliminate your eligibility altogether. If you do qualify, it’s one of the most effective ways to keep more of your home sale proceeds tax-free.
In high-demand and highly-appreciated housing markets, such as California, Florida, and New York, it’s not uncommon for homeowners to realize $1 million or even more in capital gains after a sale. If your gain is $900,000 and you’re married filing jointly, you can exclude taxes on the first $500,000, but the remaining $400,000 is taxable. That leftover amount is subject to capital gains tax, which could result in significantly higher costs depending on your income bracket and state taxes.
This is the fork in the road. Do you accept the tax liability as inevitable? Or do you explore options to defer those gains and reinvest with full leverage?
How a DST Can Help
A DST is a legal structure that allows you to defer paying capital gains taxes by selling your home to a trust in exchange for a note. The trust sells your home to the buyer and holds the proceeds. Instead of receiving a lump sum and incurring tax liability, you can receive payments of the proceeds over time based on the promissory note. This tax strategy distributes tax liability over multiple years.
The power of this structure lies in timing. Because the trust holds the funds and you only realize gain when you receive payments of the principal, you control the tax recognition timeline. This not only softens the blow of taxation but can also result in paying taxes in lower brackets if your income decreases in retirement.
Another advantage? You can invest the funds within the trust, allowing for compounding growth over time. The strategy allows you to expand your wealth.
Why Choose a DST for a Primary Residence
The IRS doesn’t allow 1031 exchanges for primary residences, but a DST is different because it’s a contractual installment sale, not a like-kind exchange.
You can sell your primary residence, even one that qualifies for the Section 121 exclusion, and still utilize a DST for the gain above that exclusion. For example, if you’re eligible to exclude $500,000 but expect $1 million in gains, you can take the first $500,000 tax-free and defer the remaining $500,000 using the DST.
This structure also offers greater flexibility than traditional tax strategies because there is:
- No like-kind property requirement
- No strict reinvestment timeline
- Full liquidity and portfolio diversification
That flexibility makes it a compelling tool if you’re moving into retirement, downsizing, or simply want to capture equity while minimizing your tax liability.
A Tax-Advantaged Exit Strategy for a Primary Home
Let’s say you’ve lived in your home for 25 years. You bought it for $300,000, and now you’re selling it for $1.3 million. That’s a $1 million capital gain.
Assuming you’re married and qualify for the $500,000 exclusion, that still leaves $500,000 in gains exposed to tax. Using a DST, you defer that gain, invest the proceeds, and create a passive income stream for years to come. Instead of writing a check to the IRS, you’ve created a legacy asset.
That’s the difference between exiting a home sale with a tax bill and turning a lifetime investment into a lifelong wealth-building vehicle.
Is It Worth the Complexity?
If the IRS exclusion already gives you up to $500,000 in tax relief, should you really pursue a DST?
Here’s how to think about it. If your gains are modest and fall within the exclusion limit, a DST is not necessary. But if your net profit exceeds the exclusion, the decision becomes both financial and strategic. Consider:
- What would it cost you to pay taxes on the excess gain?
- What could you earn by keeping that capital invested instead?
- How would minimizing your tax bill impact your retirement or estate plan?
In many cases, the benefit of keeping that capital working for you, compounding tax-deferred, far outweighs the cost of establishing and managing a DST. Especially if you’re working with a trusted team that ensures IRS compliance and customizes your note to match your goals.
Know Your Thresholds, Know Your Tools
The Section 121 exclusion is a powerful tool. But for many high-net-worth homeowners, especially in appreciating markets, it’s only part of the picture. If your gains exceed that exclusion, or you simply want to defer capital gains tax on real estate, you owe it to yourself to consider a DST.
You worked hard for your home. Now it’s time for your home to work hard for you.
Video
Infographic
If you’ve gained significantly from a luxury home sale or hot market, the IRS exclusion may fall short. Deferral strategies, such as Deferred Sales Trusts (DST), can help postpone taxes and preserve wealth. This infographic reveals six reasons to defer capital gains on your primary home sale.
1https://www.irs.gov/taxtopics/tc701
2https://www.congress.gov/crs-product/RL32978#:~:text=Gain%20up%20to%20$250%2C000%20for%20single%20taxpayers,two%20years%20out%20of%20the%20last%20five).