The basic rules
IRC Section 121 allows you to exclude up to $250,000 of gain from the sale of a principal residence if you are single, or $500,000 if married filing jointly. To qualify, you must have owned the home and used it as your principal residence for at least 2 of the 5 years before the sale. The 2-year ownership and use periods do not need to be continuous — they just need to total 24 months in the 5-year lookback window. You can use the exclusion once every two years.
Depreciation recapture is not excluded
A common misconception: the Section 121 exclusion does not shelter depreciation recapture. If you ever rented the home and claimed depreciation (or converted it from a rental), the accumulated depreciation must be recaptured as unrecaptured Section 1250 gain at up to 25%, even if the rest of the gain is fully excluded. Only gain attributable to appreciation after any rental period — and within the Section 121 limits — can be excluded.
Partial exclusion for rental or business use
For a property with a history of both personal and rental use, the Section 121 exclusion applies only to the gain attributable to personal-use periods. Gain allocable to periods when the property was not used as a principal residence — including any rental period after May 6, 1997 — is not eligible for exclusion. This is called 'non-qualified use,' and the gain attributable to it remains taxable even if you meet the 2-year use test overall. Convert a rental to a primary residence, hold it two years, and you still owe tax on the gain built up during the rental period.
Frequently asked questions
Does the Section 121 exclusion cover depreciation recapture?
No. Depreciation recapture from rental use is always taxable — the exclusion covers only the capital appreciation gain up to the dollar limits.
Can I convert a rental to a primary home and use Section 121?
Yes, if you then live there for 2+ of the 5 years before sale. But the gain attributable to the rental period (non-qualified use) remains taxable even after meeting the use test.
How often can I use the Section 121 exclusion?
Once every two years. You cannot exclude gain from a home sale if you excluded gain from another home sale within the prior two years.
Sources
- IRS Publication 527 — Residential Rental Property
- IRS Topic No. 701 — Sale of Your Home
- IRS Publication 523 — Selling Your Home
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.