Live in your primary residence for at least two of the last five years and you can exclude up to $250,000 of profit from capital gains tax when you sell, or $500,000 for married couples. Keep records of home improvements, which raise your cost basis and shrink the taxable gain. Learn the residency rule before you list, not after.
The IRS calls it the Section 121 exclusion, and most sellers qualify without realizing how much is at stake. Get the timing wrong and a six-figure tax bill can land on profit you assumed was yours.
The rule has two tests. You need to have owned the home for at least two of the five years before the sale, and lived in it as your primary residence for at least two of those five years. The two years don’t have to be consecutive, and the ownership and residency periods don’t have to overlap.
For the full $500,000, both spouses must meet the residency requirement, though only one needs to own the home. You can use the exclusion as often as every two years. Second homes and rental properties don’t qualify.
Your taxable gain isn’t the difference between what you paid and what you sold for. Start with the sale price, subtract selling costs like agent commissions, then subtract your cost basis. Your basis is the original purchase price plus every capital improvement you’ve made since. A new roof, a kitchen remodel, a finished basement. Each one raises your basis and shrinks the gain, which matters most when your profit approaches the cap. Routine repairs and repainting don’t count.
Pull your closing documents, gather improvement receipts, and run the math before you set a price. If you’re a few months short of the two-year mark, waiting can be worth tens of thousands of dollars. If a job change, health issue, or another unforeseen event forces an early sale, you may still qualify for a partial exclusion.
Start the improvement file the day you move in, not the week you sell. When the gain is big, that folder of receipts can be worth as much as the remodel itself.
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