Thanks to Internal Revenue Code 121, if you own and occupy your principal residence an "aggregate" two of the five years before its profitable sale, up to $250,000 of your profit is tax free. A married couple filing jointly can claim up to $500,000 tax-free profits.

This tax benefit is available to any home seller, not just those who buy, renovate and sell fixer-upper houses. But it is an extra benefit for smart home buyers who purchase a fixer-upper house at a bargain price, move in, and fix it up before selling after at least 24 months of occupancy.

Another alternative, for investors, is to make tax-deferred Internal Revenue Code 1031 exchanges of fix-up houses purchased as investments. After fixing up, the upgraded house can qualify for a tax-deferred trade for another fixer-upper property of equal or greater cost. There is no minimum holding period for such investment properties.

The most profitable improvements add at least $2 in market value for every $1 spent. The best example is paint. Often, painting the exterior and interior of a house will add thousands of dollars to its market value, usually at minimal cost.

Other profitable improvements that often add more value than they cost include new carpets, fresh landscaping, new light fixtures, refinished or new kitchen cabinets, cleaning and repairing. My personal value-added favorite is to add a white picket fence around the front yard. But ask any experienced real estate agent, "What is the most difficult type of house to sell?" and this will probably be the answer: "a fixer-upper."

The reason is most home buyers want to purchase a residence in near "model home" condition.

As a longtime investor in fixer-uppers, I've bought sound, well-located fixer-uppers that only needed a coat of paint (the most profitable improvement of all) and a few other cosmetic repairs to make them into model-home condition. I've also seen, but never bought million-dollar "fixer" houses, which can best be described as "wrecking ball material."

One of the most profitable fix-ups I purchased was a run-down house in the center of a middle-class neighborhood of well-maintained houses. I ended up making a big profit.

But keep this in mind: You should think long and hard about living in a home while fixing it up.