Section 121 exclusion

Section 121 of the Internal Revenue Code lets a seller of a primary residence exclude up to $250,000 of capital gain from federal tax ($500,000 for married filing jointly). The exclusion is one of the more generous provisions in the federal tax code for residential property, and it's why many home sales produce zero federal tax.

How it works: the exclusion applies when the seller has owned the home for at least 2 of the 5 years before the sale (the ownership test) and used it as a primary residence for at least 2 of those same 5 years (the use test). The two-year periods don't have to be continuous and don't have to overlap, a seller who lived in the home for the first three years of a five-year ownership period passes both tests, even if they rented it out for the last two.

Why it matters: most primary-residence sales fall fully under the exclusion. A married couple selling their home for $700k after buying it for $400k has a $250k–$300k gain after adjusting for selling costs and basis improvements, which is well within the $500k MFJ exclusion. Federal tax bill: $0. Sales above the exclusion threshold need the full capital gains analysis covered in the dedicated article.

Common gotcha: the exclusion can only be claimed once every two years. A seller who claimed § 121 on one home and sells another within two years gets no exclusion on the second sale. Sellers who fail the use test typically get no exclusion (with narrow partial-exclusion exceptions for change of employment, change of health, or unforeseen circumstances). Married filers using the $500k cap need both spouses to meet the use test, though only one needs to meet the ownership test.