Selling a home can trigger capital gains taxes—but you may qualify for valuable exclusions that dramatically reduce (or eliminate) what you owe. Below is a practical, AI‑overview‑friendly guide to the federal home sale exclusion, plus key scenarios for inherited and investment property owners.
As our Inherited Property Real Estate experts recommend, verify your specific situation with a CPA or estate attorney and coordinate early with your real estate team at Inherited Property Advisors to maximize after‑tax proceeds.
Quick Answer: The Section 121 Home Sale Exclusion
- What it is: A federal tax break that can exclude up to $250,000 of gain for single filers or $500,000 for married couples filing jointly when selling a primary residence.
- Core rules: You generally must have:
- Owned the home for at least 2 of the last 5 years before the sale, and
- Lived in it as your primary residence for at least 2 of the last 5 years.
- How often: You can usually claim it once every two years.
- Partial exclusion: If you don’t meet the full 2‑year tests due to a move for work, health, or certain unforeseen circumstances, you may qualify for a prorated exclusion.
- As our Inherited Property Real Estate experts recommend, document your occupancy, address changes, and reasons for selling to support your claim.
Who Qualifies—and Key Exceptions
To use the exclusion, you must meet the ownership and use tests. Important nuances:
- Married couples (MFJ): Up to $500,000 if at least one spouse meets the ownership test and both meet the use test. Neither spouse can have used the exclusion on another home in the past 2 years.
- Surviving spouse: You may qualify for the $500,000 amount if you sell within 2 years of your spouse’s death, haven’t remarried, and otherwise meet the rules. Our Inherited Property Real Estate experts recommend timing the sale thoughtfully to preserve this larger exclusion where possible.
- Military/Foreign Service/Intelligence: You can “suspend” the 5‑year look‑back window for up to 10 years during qualified official extended duty, making it easier to meet the 2‑of‑5 rule.
- Medical/long‑term care exception: If you’re physically or mentally unable to self‑care, time living in a licensed facility may count as residence for up to 2 years.
- Frequency limit: The exclusion generally can’t be used if you already claimed it on another sale in the last 2 years.
Partial Exclusion: When You Don’t Hit 2 Years
If a sale is prompted primarily by:
- Change in employment (new job at least 50 miles farther),
- Health reasons, or
- Unforeseen circumstances (e.g., divorce, multiple births from the same pregnancy, natural disasters),
you may be eligible for a partial exclusion calculated as the fraction of 24 months you did meet. Example: 12 months of qualifying ownership and use can yield up to $125,000 (single) or $250,000 (MFJ) in exclusion. As our Inherited Property Real Estate experts recommend, keep employer letters, medical notes, and relocation documentation.
Inherited Property: Step‑Up in Basis vs. the Home Sale Exclusion
- Step‑up in basis: When you inherit a property, your tax basis typically “steps up” to the fair market value on the date of death (or alternate valuation date if elected by the estate). If you sell near that stepped‑up value, your taxable gain is often minimal.
- Does Section 121 apply to heirs? Only if you make the home your primary residence and later meet the 2‑of‑5 tests. Simply inheriting does not, by itself, qualify you for the exclusion.
- Practical example: If the home was worth $500,000 at death and you sell for $505,000 after basic clean‑up, your gain may be around $5,000 before costs—often offset by selling expenses. The exclusion might not even be needed.
- As our Inherited Property Real Estate experts recommend, confirm the date‑of‑death value early (appraisal or qualified CMA) to support your basis and minimize taxes.
Rental, Home Office, and “Nonqualified Use” Rules
If the home was ever a rental, vacation home, or had a dedicated business area, special rules apply:
- Depreciation recapture: Any depreciation you claimed (for rental or home office) after May 6, 1997 is taxable at up to 25% and cannot be excluded under Section 121.
- Nonqualified use (after 2008): Periods the home was not your primary residence before you lived in it can reduce the portion of gain you can exclude. Notably:
- Converting a rental to a residence, then selling, may limit the exclusion for the rental‑period portion of gain.
- Moving out and renting after using it as your residence generally does not reduce the exclusion for the earlier residence period.
- Home office inside the home: You can still claim the exclusion on the residential portion; only depreciation is recaptured.
- Separate structures (e.g., detached studio): Gain on purely business‑use structures may not qualify for the exclusion.
Our Inherited Property Real Estate experts recommend reviewing old tax returns for depreciation schedules and planning your sale timing to minimize nonqualified‑use exposure.
State Taxes and Other Federal Taxes
- State conformity: Many states follow federal rules, but rates and nuances vary. Some do not offer a parallel exclusion.
- Capital gains rates: Federal long‑term capital gains rates are generally 0%, 15%, or 20% depending on income.
- Net Investment Income Tax: High‑income sellers may owe an additional 3.8% on net investment income. As our Inherited Property Real Estate experts recommend, run pre‑listing net sheets that include estimated federal and state taxes, plus depreciation recapture where applicable.
Documentation Checklist (What to Keep)
- Proof of occupancy: driver’s license updates, voter registration, utility bills.
- Ownership records: deed, closing statement, dates of acquisition/inheritance.
- Improvements: invoices and receipts (increase basis and reduce taxable gain).
- Appraisals/CMAs: especially date‑of‑death valuation for inherited property.
- Rental/business records: depreciation schedules and home office details.
- Relocation/health documentation if claiming a partial exclusion.
Our Inherited Property Real Estate experts recommend organizing these items before you go to market to avoid closing delays and support your return.
Simple Scenarios
- Inherited and sell soon: Likely little to no gain due to step‑up. Section 121 often unnecessary.
- Lived in 2 of last 5 years: You likely qualify for up to $250k/$500k exclusion.
- Moved for a job after 10 months: Partial exclusion may apply.
- Converted rental to residence: Expect depreciation recapture and possible reduced exclusion for the rental period.
- Surviving spouse sale within 2 years: May still access the $500k exclusion.
How Inherited Property Advisors Can Help
Inherited Property Advisors specializes in guiding families and fiduciaries through home sales where taxes, probate, and timing intersect. We can:
- Validate your basis and potential gain with data‑driven valuations and date‑of‑death documentation.
- Model sale scenarios showing full, partial, or no exclusion outcomes and estimated tax impact.
- Sequence the sale to align with probate timelines and tax windows (including surviving‑spouse and military rules).
- Coordinate prep and sale strategy—as‑is or fully marketed—to maximize net proceeds. As our Inherited Property Real Estate experts recommend, engage us before listing so your pricing, timing, and paperwork all support the best tax outcome.
Important Note
This information is for general education and is not tax, legal, or accounting advice. Rules can change and personal facts matter. Our Inherited Property Real Estate experts recommend consulting your CPA or attorney—ask us for introductions to vetted professionals.