Are you planning to sell your home? You may be able to exclude a portion of the profit of the home sale from your taxable income through the Section 121 exclusion. Let’s explore some of the details of this tax-saving tool and how you can qualify.
How are capital gains calculated?
Capital gains are equal to the profit you make when you sell your home.
In other words…
Capital Gains = Sale Price – (Purchase Price + Capital Improvements + Costs to Purchase/Sell the Home)
Capital gains on the sale of a home are subject to capital gains taxes, as they are considered a form of income. Short-term capital gains (capital gains from the sale of assets held for one year or less) are taxed as ordinary income. Long-term capital gains (capital gains from the sale of assets held for longer than a year) are taxed at three different rates (0%, 15%, or 20%), depending on income and filing status.
What is the Section 121 exclusion?
The Section 121 exclusion allows you to exclude from your taxable income up to $250,000 of capital gains (profit) from the sale of your home. Married couples filing jointly can exclude up to $500,000. This exclusion applies to a range of properties including single-family homes, condos, cooperative apartments, mobile homes, and houseboats. However, you must meet certain conditions to qualify for this tax benefit. It is important to note that most states follow the exclusion, but the rules may vary from state to state.
How can you qualify?
To qualify for the Section 121 exclusion, you must meet an ownership test as well as a use test. You must have owned and used the property as your primary residence for at least two of the five years preceding the sale of the home. The two years do not have to be consecutive, but the total time you have lived in the home must add up to at least two years (24 months). In the case of married couples, only one spouse must meet the ownership requirement, but both spouses must meet the residence (use) requirement individually in order to qualify. If you own and live in more than one home, you must use a “facts and circumstances” test to determine which property qualifies as your main home. A person can only own one “main home” at a time.
What makes you ineligible?
You are not eligible for the Section 121 exclusion if you acquired the property through a like-kind exchange (1031 exchange) within the last five years or if you are subject to expatriate tax. In addition, if you sold another home within the two-year period preceding the home sale and claimed the Section 121 exclusion on that sale, you cannot qualify for the exclusion again. Individuals may only take the exclusion once within a two-year period. There are some exceptions to the eligibility test based on circumstances such as separation or divorce during home ownership, death of a spouse, or status as a service member. A full list of exceptions to the eligibility test can be found here.
Do you qualify for a partial exclusion?
Though you may not qualify for a maximum exclusion based on the eligibility requirements, you may still qualify for a partial exclusion. You may qualify for a partial exclusion if your reason for moving is due to a change in workplace location, health-related events, or unforeseeable events (i.e., your home was destroyed or condemned, death of a homeowner, divorce, etc.).
Looking for more information or guidance?
For additional information on the Section 121 tax exclusion, including worksheets for calculations, visit IRS Publication 523 (2024), Selling Your Home. For guidance on how you can make the most of capital gains exclusions and other tax-saving opportunities in the real estate market, you can rely on our experts at RBT CPAs. Our experienced professionals are here to support all of your tax, audit, accounting, and advisory needs. Give us a call today to find out how we can be Remarkably Better Together.