The Section 121 exclusion lets you exclude up to $250K ($500K for married couples) in profit from your taxes when you sell your primary residence. Requirements: you must have owned AND lived in the home for 2 of the last 5 years before the sale. This means you can rent it for up to 3 years and still qualify.
You can use this exclusion once every 2 years. It is one of the largest tax benefits available to homeowners.
The 2-Year Rule
To qualify for the full exclusion, you must have both owned and lived in the home as your primary residence for at least two years (730 days) during the five-year period ending on the date of sale. The two years do not need to be consecutive. Short absences for vacations count as time lived in the home.
Single vs Married Exclusion
Single filers can exclude up to $250K of capital gains. Married couples filing jointly can exclude up to $500K if both meet the ownership and use test. If only one spouse meets the requirements, the exclusion is limited to $250K.
How to Calculate Your Gain
Your gain = sale price minus selling costs (commissions, closing costs) minus adjusted basis (original purchase price plus capital improvements). Document your improvements (new roof, HVAC, kitchen remodel) because they increase your basis and reduce your taxable gain.
Partial Exclusion
If you do not meet the 2-year requirement, you may qualify for a partial exclusion due to job change (new job more than 50 miles away), health reasons, or unforeseen circumstances like divorce, multiple births, or death. The partial exclusion is proportional to the time you lived in the home.
