Sale of Primary Residence (Section 121)

IRC Section 121 provides one of the most generous tax benefits available to individual taxpayers: the exclusion of gain from the sale of a principal residence.

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Exclusion Amounts

Important: The exclusion applies only to gains, not losses. Losses from the sale of a personal residence are not deductible.

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Ownership and Use Tests

To qualify for the full Section 121 exclusion, you must meet both tests:

Ownership Test

You must have owned the home for at least 2 years (24 months) during the 5-year period ending on the date of sale.

Use Test

You must have used the home as your principal residence for at least 2 years (24 months) during the 5-year period ending on the date of sale.

Key Flexibility Rules

1. Non-consecutive periods allowed: The 24 months do NOT need to be continuous
2. Different 2-year periods: The ownership and use tests can be satisfied during different 2-year periods

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The "Once Every 2 Years" Limitation

You can claim the Section 121 exclusion only once every 2 years. If you excluded gain from the sale of another home during the 2-year period ending on the date of sale, you are not eligible for the exclusion.

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Married Couples: Special Rules

Qualifying for the $500,000 Exclusion

Married couples filing jointly can exclude up to $500,000 if:

1. Either spouse meets the ownership test
2. Both spouses meet the use test
3. Neither spouse is ineligible due to claiming an exclusion in the prior 2 years

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Surviving Spouse Rules

A widowed taxpayer may claim the full $500,000 exclusion if:

1. The sale occurs within 2 years of the spouse's death
2. The couple would have qualified for the $500,000 exclusion immediately before the death
3. The surviving spouse has not remarried before the sale

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Reduced Exclusion for Unforeseen Circumstances

Taxpayers who fail to meet the full requirements may qualify for a prorated exclusion if the sale is due to:

1. Change in place of employment (new job at least 50 miles farther from residence)
2. Health reasons
3. Unforeseen circumstances (death, divorce, multiple births, unemployment, natural disaster)

Calculating the Reduced Exclusion

Formula: Maximum Exclusion × (Qualifying Months / 24 Months)

Example: Single taxpayer owned and lived in home for 12 months before selling due to job relocation: $250,000 × (12/24) = $125,000

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Home Office Implications: Depreciation Recapture

Any depreciation claimed after May 6, 1997 must be recognized as gain:

• Taxed at a maximum rate of 25% (as unrecaptured Section 1250 gain)
• Cannot be excluded under Section 121

Simplified Home Office Method Exception: Taxpayers using the simplified method ($5/sq ft) treat depreciation as zero—no recapture required.

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EA Exam Tips

1. Memorize the thresholds: $250,000 single / $500,000 MFJ
2. "2 of 5" rule: Both ownership AND use tests require 2 years within the 5-year lookback period
3. "Once every 2 years": Separate limitation—can only claim one exclusion per 2-year period
4. Surviving spouse window: 2 years from date of death for $500,000 exclusion
5. 50-mile employment safe harbor: New job must be at least 50 miles FARTHER from residence
6. Depreciation always recaptured: Home office depreciation cannot be excluded
7. No loss allowed: Personal residence losses are never deductible