Within the last 2 years, the IRS has been allowing taxpayers to mix the rules applied to the sale of their principal residence and those of IRC 1031 tax deferred exchanges. A welcome turn in this market where homes values have skyrocketed upward and produced gains well above the current $250,000/$500,000 capital gains tax exclusions afforded by the IRS.

If you don't know already, the IRS allows a seller to exclude from capital gains taxes, upto $250,000 from the sale of his principal residence if he's lived in it for 2 of the last 5 years. ($500,000 if married) Any amount over that would be subject to taxation. So if a seller nets a profit of 350,000, the portion subject to tax would be $100,000.

If the seller can rent the home for 2 years before the sale, that 100k could then be rolled into another investment property and excluded from gains tax. The investment could also produce income for the seller as long as he owns the investment property. That income though, would presumably be taxed at the owner's low income tax rate, not as gains.

Strategies like this can get complicated and before making the decision to make a transaction like this, you should consult with your CPA or Tax Advisor.