The Section 121 Exclusion: How to Sell Your Home Tax-Free (Up to $500k)
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Result: Keeping receipts saved $23,800 in Capital Gains Tax.
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The Section 121 Exclusion: How to Sell Your Home Tax-Free (Up to $500k)
CORE INSIGHTS
- The $500k Shield: Married couples can exclude up to $500,000 of capital gains from their home sale (Single: $250k). This gain is 100% tax-free, not just deferred.
- The “2-out-of-5” Rule: You must own and live in the home for at least 2 of the 5 years before the sale. These 2 years do not need to be consecutive.
- Basis is Key: Your profit is (Sale Price – Cost Basis). Documenting “Capital Improvements” (renovations) raises your basis and shrinks your taxable gain.
For most Americans, their home is their largest asset. IRC Section 121 is the tax code’s greatest gift, allowing you to walk away with half a million dollars tax-free. However, exceeding this limit triggers a massive tax bill. The key is managing your Cost Basis.
What-If Scenario: The Remodel Benefit ($900k Sale)
| Scenario | Adjusted Basis | Taxable Gain |
|---|---|---|
| No Records | $200,000 (Original) | $200,000 Taxable |
| With Receipts | $300,000 (+100k Reno) | $100,000 Taxable |
Visualizing the Exclusion Stack
*Figure 1: Anatomy of a Sale. Capital Improvements (Blue) directly reduce the Taxable Gain (Red).*
Strategic Action Steps
1
Differentiate Repairs vs. Improvements
Fixing a broken window is a “Repair” (No benefit). Replacing all windows is an “Improvement” (Adds to Basis). Keep a permanent file.
Fixing a broken window is a “Repair” (No benefit). Replacing all windows is an “Improvement” (Adds to Basis). Keep a permanent file.
2
Track Closing Costs
When you sell, agent commissions (5-6%) and transfer taxes are deductible from the sale price. Don’t forget them.
When you sell, agent commissions (5-6%) and transfer taxes are deductible from the sale price. Don’t forget them.
3
The “Step-Up” Bailout
If your gain is massive (e.g., $2M gain), consider holding until death. The Step-Up in Basis (#69) wipes out 100% of gains for heirs.
If your gain is massive (e.g., $2M gain), consider holding until death. The Step-Up in Basis (#69) wipes out 100% of gains for heirs.
The Bottom Line: Who Should Choose What?
- Sell Now: If gain is under $500k (couple) and you want to downsize tax-free.
- Hold: If gain is >$500k and you are elderly. The tax bill might be too high; holding for heirs is better.
Frequently Asked Questions
What is the 2-out-of-5 Year Rule?
You must own and live in the home for at least 24 months out of the 5 years preceding the sale. Months do not need to be consecutive.
Can I use Section 121 on a rental property?
Only if you convert it. If you move in and live there for 2 years, you may qualify for a partial exclusion, but you still owe depreciation recapture tax.
What increases my Cost Basis?
Capital Improvements increase basis (new roof, room addition, HVAC). Routine repairs (painting, fixing leaks) do NOT count.
Disclaimer: This content is for informational purposes only. Consult a CPA.