Ask the Taxgirl: Mitigating Tax by Investing

Taxpayer asks:

Can I reduce or eliminate taxes from civil suit and punitive damages winnings by immediately investing in a home?

Taxgirl says:

Unfortunately, no. You can’t reduce or eliminate taxes from the proceeds of a lawsuit by investing them in real estate—or any other kind of asset.

I think you might be thinking of the pre-1997 rule that let homeowners get a break if they used the proceeds from selling their primary home to buy another home. That rule was eliminated, and now homeowners can exclude capital gains of $250,000—$500,000 for married taxpayers—when they sell their homes, regardless of age or whether they buy a replacement property.

For other kinds of income, including lawsuit proceeds, there’s no immediate tax benefit to simply flipping it into a home. There might be a personal benefit—a place of your own—and a possible tax benefit down the road—real estate and mortgage deductions—but you must still report the original income on your taxes.