Nobody likes to miss out on tax-free money, but plenty of homeowners are unaware that they could be eligible for up to $500,000 in tax-free profits when selling their home. Even though Congress instituted the largest tax law changes since 1986 with the “Tax Cuts and Jobs Act” in 2017, we still have one of the best tax saving provisions available for exclusion of primary residence gains. Read on to learn more information about these provisions, courtesy of CPA Scott W. Taylor…

Under the home-sale exclusion rule, you may be able to exclude a portion, or possibly all, of the gain realized from the sale of your home if your home met the principal residence rules. During the five-year period ending on the date of the sale you must have owned and used the property as your principal residence for a period aggregating two or more years. You need not have lived there continuously to qualify. You may use the exclusion provided the eligibility requirements are met, but generally no more frequently than once every two years.

The amount of the exclusion is generally limited to $250,000 for single individuals and married individuals filing separately. The exclusion is increased to $500,000 in the case of married couples filing a joint return, where…

1. At least one spouse meets the ownership requirement.
2. Both spouses meet the use requirement.
3. Neither spouse is ineligible for the benefits because he or she excluded gain on the sale or exchange of a home under the new provision within the past two years.

The $500,000 exclusion amount also applies to a sale by a surviving spouse—who can claim the full exclusion if the home is sold within two years of their spouse’s death (provided the ownership and use requirements are otherwise met). If a taxpayer marries someone who is ineligible, the taxpayer generally remains eligible for a maximum exclusion of $250,000.

If you fail to meet the ownership and use requirements due to a change in place of employment, health, or other unforeseen circumstances, you may exclude a fraction of the $250,000/$500,000 amount.

Special rules apply in determining ownership and use if you are receiving out-of-residence care, inheriting property from a spouse, transferring property pursuant to a divorce, or disposing of property where the rollover rules applied.

The exclusion rule also generally applies to the sale of a remainder interest in a principal residence, if all the other requirements are met. Thus, you may retain a life estate in your home while selling the remainder interest.

The exclusion rule requires gain recognition to the extent of any depreciation taken after May 6, 1997, for the rental or business use of your home.

If you have a gain in excess of $250,000 ($500,000 if married and filing jointly) when you sell your home, you will now be liable for income tax on the excess gain in the year of sale. No deduction is allowed if your home is sold at a loss.

You should meet with your CPA to discuss the application of these provisions to your particular situation.

Examples

Scenario: Married Couple Filing Jointly

• Bought home in 2010 for $400,000
• Sold home in 2025 for $1,000,000
• They lived in the home as their primary residence for at least 2 of the past 5 years

Calculation of Gain:

• Sale price: $1,000,000
• Purchase price (basis): $400,000
• Capital gain: $1,000,000 – $400,000 = $600,000

Exclusion under TCJA:

They meet the requirements:

• Ownership and use test: They lived in the home for at least 2 years out of the last 5
• Filing jointly: So they qualify for the $500,000 exclusion
• Excludable gain: $500,000
• Taxable gain: $600,000 – $500,000 = $100,000

Example 1: Both Spouses Lived in the Home Prior to Marriage

• Spouse A owned the home for 5 years
• Spouse B moved in 3 years ago
• They got married 1 year ago
• Both spouses lived in the home for at least 2 years
• Spouse A meets the ownership test
• They qualify for the full $500,000 exclusion

Example 2: Spouse Moved in After Marriage

• Spouse A owned and lived in the home for 5 years
• Spouse B married Spouse A and moved in only 1 year ago
• Spouse B does NOT meet the 2-year use test
• Only Spouse A qualifies
• They qualify for only $250,000 exclusion but not the full $500,000, because both spouses must meet the use test
• Both meet use test – $500,000 exclusion allowed
• Only one meets use test – $250,000 exclusion allowed

Scenario: Mixed Use (Rental + Primary Residence)

• Married couple, filing jointly
• Bought home in 2012 for $300,000
• Rented it out from 2012 to 2018 (6 years)
• Moved in and lived there from 2019 to 2024 (5 years)
• Sold in 2025 for $900,000
• Total gain = $600,000
• During the rental period, depreciation taken = $90,000

Ownership and Use Test

• They owned the home for 13 years (since 2012)
• They lived in it as primary residence for 5 of the last 5 years before the sale so they qualify for the $500,000 exclusion

Depreciation Recapture (Non-Excludable)

• Even though they qualify for the exclusion, any depreciation claimed during rental use must be recaptured
• Depreciation taken = $90,000
• This portion must be reported as unrecaptured Section 1250 gain, taxed up to 25%

Capital Gain Breakdown:

• Sale Price: $900,000
• Cost Basis (Original Purchase): $300,000
• Total Gain: $600,000
• Less: Depreciation (non-excludable): $90,000
• Excludable Gain: $500,000 (max)
• Taxable Gain (depreciation): $90,000
• Remaining Gain: $600,000 – $90,000 = $510,000
• $510,000 – $500,000 excluded = $10,000 taxable
• $90,000 of depreciation recapture → taxed (up to 25%)
• $10,000 of gain over the $500,000 limit → taxed as long-term capital gain
• The rest of the gain → excluded from tax

Summary points

• Rental use doesn’t disqualify you from the exclusion if you meet the 2-year use and ownership tests.
• Depreciation taken during rental use is always taxable, even if you qualify for the exclusion.
• Capital gain above the $500,000 exclusion is also taxable.

Teaser for Importance of Appraisals:

• A date-of-death appraisal is highly recommended to establish FMV.  This directly relates to TCJA primary residence exclusions.
• Done by a licensed real estate appraiser.
• Important for: Capital gains tax planning, estate tax filings (if applicable), and distributing the estate fairly among heirs.