Sell Your Home Tax-Free: The Section 121 Exclusion Guide
If you make $100,000 in the stock market, you pay taxes. If you make $100,000 selling your crypto, you pay taxes. But thanks to IRS Section 121, if you make $500,000 selling your home, you can legally pay $0 in federal taxes. It is arguably the single greatest wealth-building tool in the US Tax Code. There is just one catch: You must follow the “2 out of 5 Years” rule perfectly. Here is how to ensure your massive windfall stays in your pocket, not the IRS’s vault.
The Golden Ticket: If you lived there for 2 years, up to $500k of profit is yours to keep. The IRS gets nothing.
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1. The Magic Numbers: $250k and $500k
This exclusion applies to your Net Profit (Capital Gain), not the total sales price.
• Sold for: $900,000
• Gain: $500,000
• Taxable Amount (Married): $500k Gain – $500k Exclusion = $0 Taxable.
👉 You keep all $500,000 profit. No form to file (usually), no tax bill.
2. The “2 out of 5 Years” Rule Explained
To qualify, you must pass two tests during the 5-year period ending on the date of sale.
| Test Name | Requirement | Notes |
|---|---|---|
| Ownership Test | Owned for 24 months | Doesn’t have to be continuous. |
| Use Test | Lived in for 24 months | Must be “Primary Residence.” (Vacation homes don’t count). |
*The 24 months do not need to be consecutive. You could live there in Year 1 and Year 5.
3. Forced to Move Early? (The Loophole)
What if you have to sell after only 1 year? You might get a Partial Exclusion if the move is due to:
- Work: Your job moved more than 50 miles away.
- Health: You moved for medical reasons (e.g., need a care facility).
- Unforeseen Circumstances: Divorce, death of a spouse, or multiple births (twins/triplets).
• Single Limit becomes $125,000.
• Married Limit becomes $250,000.
4. The Trap: Did You Rent It Out?
If you rented the house out for a few years, things get complicated.