Sell your home for a profit and the IRS usually wants a slice. But Internal Revenue Code Section 121 gives most owner-occupants a permanent exemption on the first $250,000 of gain if single, $500,000 if married filing jointly. Understanding the rules means you keep more at closing.
The two-of-five-year test
To qualify, you must have owned the home for at least two years out of the five years before the sale and used it as your primary residence for at least two of those five years. The ownership and use periods don't have to overlap perfectly, but both clocks must hit twenty-four months. You can claim the exclusion once every two years. A couple who bought in March 2020, lived there until April 2022, then rented it out can still sell in early 2025 and claim the exclusion because both the ownership and use tests look back five years from closing.
How much you exclude
Single filers exclude up to $250,000 of gain; married couples filing jointly exclude up to $500,000. Gain equals sale price minus your adjusted basis—purchase price plus closing costs, plus the cost of capital improvements (new roof, addition, HVAC replacement), minus any depreciation if you rented the property. If you bought for $300,000, spent $40,000 on a kitchen remodel, and sell for $610,000, your gain is $270,000. A married couple pays zero federal capital-gains tax; a single filer pays tax only on the $20,000 above the exclusion threshold.
Partial exclusions
Fail the two-year test because of a job relocation more than fifty miles away, a health issue requiring a move, or certain other unforeseen events, and you can claim a pro-rata exclusion. Live in the home twelve months instead of twenty-four and you qualify for half the cap—$125,000 single, $250,000 joint. The IRS safe-harbor list covers military orders, qualified official extended duty, and specific health and employment changes. Document everything; the burden of proof is yours.
Records to keep
The exclusion is only as good as your paperwork. Save the settlement statement from your purchase, every invoice for capital improvements, and proof of any costs rolled into basis. If you converted the home from rental to personal use or vice versa, keep depreciation schedules and Form 8949 worksheets. The IRS has three years from filing to audit, longer if gain is understated by more than twenty-five percent. A missed $30,000 improvement receipt can cost you $4,500 in unnecessary tax at the fifteen-percent long-term capital-gains rate.
The Alliance take
Section 121 is one of the best wealth-building provisions in the tax code, but it rewards careful record-keeping and planning. Consult a CPA or attorney; this is not tax or legal advice. If you're months away from the two-year mark and considering a sale, waiting can save five figures. When you're ready to buy or refinance your next home, start an application and we'll walk you through the financing side with the same attention to detail.