When selling a home, the profit—called capital gain—is generally taxable. However, the IRS offers a significant tax break for your principal residence under the Section 121 exclusion. This allows homeowners to exclude up to $250,000 (or $500,000 if married filing jointly) of capital gains from their taxable income, provided certain conditions are met.
How to Qualify for the Principal Residence Exclusion
You must satisfy two main IRS criteria within the five years preceding the sale:
- Ownership Test: You must have owned the home for at least two of the last five years.
- Use Test: You must have lived in the home as your principal residence for at least two of the last five years.
These periods don’t need to be continuous. For example, living in the home for one year, renting it out for two, then living there again for another year can qualify.
Identifying Your Principal Residence
If you own multiple properties, only one can be your principal residence at a time for tax purposes. The IRS looks at various factors to determine which home qualifies, such as:
- Mailing address used for important documents
- Voter registration location
- Address on your driver’s license or state ID
- The address used on your federal and state tax returns
- Proximity to your workplace
- Where your family and social life are centered
This holistic review helps establish your main home without requiring a formal “principal residence declaration” form.
Important Considerations
- You can generally claim this exclusion once every two years.
- Gains related to periods when the home was not your principal residence, such as rental use, may be taxable through depreciation recapture.
- Special partial exclusions apply for sales due to job changes, health issues, or other qualifying unforeseen circumstances.
For more detailed guidance, see IRS Publication 523, “Selling Your Home” (https://www.irs.gov/publications/p523) and our related article on Capital Gains Exclusion on Home Sale.
Understanding the ins and outs of your principal residence can help you maximize tax savings when selling your home. For homeowners, this knowledge is key to making informed decisions and minimizing tax liability.
