You may not have included the equity in your home when calculating your retirement savings. The thinking was that you would always have a home and that any equity build-up would go into the next home, which would always be more expensive. It may be time to change that thinking.

Prior tax laws allowed you to "roll over" or "buy up" in order to defer any tax on the gain in the value of your home to a later sale. Then came the "over 55, once-in-a-lifetime" rules allowing exclusion of $125,000 of such gain. Those rules are now out the window.

Generally, after May 6, 1997, each taxpayer may exclude from income up to $250,000 of gain realized on the sale or exchange of a principal residence, provided the taxpayer owned and occupied the property as his or her principal residence for an aggregate of at least two of the five years before the sale or exchange and has not elected to apply the exclusion to another sale or exchange with the last two years. Married taxpayers who file a joint tax return may exclude up to $500,000 of gain realized if:

1. either spouse meets the ownership requirement;
2. both spouses meet the occupancy requirement; and
3. neither spouse is ineligible for the exclusion by virtue of a sale or exchange of a residence within the last two years.

That is $500,000 (a half-million dollars) TAX-FREE! The two year ownership and use requirements do not need to be continuous. The residence does not have to be the taxpayer’s principal residence at the time of the sale. The new rules allow you to take up to $250,000/$500,000 of your home sale profits tax-free regardless of your age, regardless of how many homes you have sold in the past or may sell in the future, and even if you previously took a "once-in-a-lifetime" exclusion. As long as you meet the qualifications, this tax exclusion is available for you. Right now.

It is hard to find a bigger income tax break. Any gains made (up to the exclusion amounts) on the sale of your home over its purchase price is after tax money--unlike the monies in your 401 (k) at work, or your IRA accounts (except the new Roth IRA), or any annuities or insurance products with "inside buildup." All of these retirement and tax avoidance vehicles defer taxes on your gains until the money is withdrawn—at which point it is subject to income tax. Section 1031 exchanges of real property also only defer taxes; they do not avoid them. So how can you use your home for retirement? Here are just a few examples:

1. Your last child finally made it through college; and all your kids are employed and independent (whew!). You and your spouse sell your big house in Old Town for $650,000. You bought it in 1985 using the equity from three prior houses you owned while "moving on up". Your tax basis is $125,000—the $25,000 you paid for your first home in 1972 and the $100,000 (carefully accounted for) in improvements made to your various homes through the years. Subtracting your basis from the sale price, your gain is $525,000. You now subtract another $500,000 from that sub-total, leaving $25,000 of long-term taxable gain. Ignoring state taxes, you owe a capital gains tax of $5,000 (20% of $25,000). You have $625,000 left after taxes! Using this money, you buy a smaller home for $325,000—still pretty nice—and add $300,000 after tax money to your retirement savings.
   
2. Perhaps you and your spouse are ready to retire. You purchased a condo in Vail in 1979 for $300,000 (way too much!). So, after selling the big house as described in example A, you move into the Vail condo. You buy another condo in Maui using the $625,000 after tax profit from the sale of the big house. As with the Vail condo, you can rent the Maui condo most of the year for retirement income or to pay its mortgage, or some of each. You can use it two weeks each year (plus time spent there working on maintenance and improvements). While you’re at your new condo in Maui, you can rent the Vail condo for two weeks and not include that rent in income. (Rent for 14 days or less per year is not reportable on your tax return—even if its $5000 per week!). After living at least two years in the Vail condo as your principal residence, you sell it for $1,000,000. You pay tax of $40,000 ($1M less $300K basis, less $500K exclusion = $200K taxed at 20%= $40K). You keep $960,000 after tax money, which can pay for quite a bit of retirement fun.
   
3. Continuing our saga, you buy your dream beach house on Nantucket Island with the $960,000 after tax savings from the sale of the Vail condo, reside in Maui at least two years, sell the Maui condo for $1M, keep it all (the $375K gain is less than the $500K exclusion), move to Nantucket—and so on.

Of course the key to taking advantage of this tax break is that each home must appreciate in value after you buy it. So buy the right property. You and your spouse are allowed to keep, tax-free, the appreciation on each home up to $500,000 ($250,000 per individual).