The Section 121 Exclusion
This is the tax break many homeowners have heard of but rarely understand clearly. If you qualify, it can shelter a large portion of your home-sale profit from federal capital gains tax.
What it does
The exclusion lets you remove up to $250,000 of gain if single or $500,000 if married filing jointly, as long as the property was your main home and you meet the ownership and use tests.
The two-out-of-five rule
- You must have owned the home for at least 2 years out of the last 5.
- You must have lived there as your primary residence for at least 2 years out of the last 5.
Those years do not need to be continuous. They also do not need to be the most recent 2 years, just inside the 5-year window before sale.
When homeowners miss it
The biggest mistakes are usually timing mistakes: moving out too long ago, renting the property for too many years before selling, or assuming a second home qualifies when it does not.
Partial exclusion
You may still qualify for a partial exclusion if you sold early because of a qualifying work move, health reason, or other unforeseen circumstance recognized by the IRS.
What it does not protect
- Depreciation recapture from rental use
- Profits above the exclusion limit
- State taxes in states that do not fully follow the federal treatment
Why timing matters
If you are close to qualifying, waiting a few months can save tens of thousands. If you are close to losing the 5-year window, waiting can cost you the exclusion entirely.
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