IRS Publication 523: Selling Your Home
IRS Publication 523 explains the tax rules when you sell your primary residence. The Section 121 exclusion is one of the most generous provisions in the tax code — allowing single filers to exclude up to $250,000 of gain ($500,000 for married filing jointly) if you owned and used the home as your principal residence for at least 2 of the last 5 years. Partial exclusions are available for work-related moves, health reasons, and unforeseen circumstances. If your gain exceeds the exclusion or you do not qualify, the excess is taxable capital gain.
Key Topics Covered in Publication 523
Section 121 Exclusion
Single filers exclude up to $250,000 of gain. Married filing jointly exclude up to $500,000. Must own and use the home as principal residence for at least 2 of the last 5 years. Exclusion available once every 2 years.
Ownership & Use Tests
The 2-out-of-5-year ownership and use tests are measured from the date of sale. Short temporary absences (vacations, seasonal travel) count as use. Military and Foreign Service members may suspend the 5-year period during extended duty.
Partial Exclusions
Reduced exclusions are available for sales before meeting the 2-year requirement due to: change in employment (50-mile rule), health reasons (medical diagnosis or treatment), or unforeseen circumstances (divorce, death, job loss, multiple births). Calculated pro rata.
Second Homes & Rental Properties
Second homes and investment properties do not qualify for Section 121 unless you convert the property to your primary residence. The nonqualified use period (after 2008) reduces the exclusion for periods the home was not used as a primary residence.
Reporting the Sale
Report on Form 8949 and Schedule D only if you received Form 1099-S, your gain exceeds the exclusion, or you do not qualify. Gain in excess of the exclusion is capital gain — long-term rates apply if you owned over 1 year.
Common Mistakes & Correction Strategies
Missing the 2-Year Rule
Selling before 2 years without a qualifying exception costs the entire exclusion. If you have a qualifying reason (work, health, unforeseen event), document it thoroughly and claim the partial exclusion — the IRS requires proof of the specific circumstance.
Wrong Cost Basis
Homeowners often forget to add capital improvements to their cost basis — new roof, addition, HVAC replacement, remodeled kitchen. These reduce your taxable gain dollar for dollar. Keep receipts and contractor invoices to substantiate each improvement.
Rental Conversion Issues
Converting a rental to a primary residence triggers the nonqualified use rules. Gain attributable to depreciation recapture is taxed at 25%. If you owned the rental before 2009, the nonqualified use period before 2009 may be excluded from the proration calculation.
Divorce & Home Sales
In a divorce, the home transfer may be tax-free under Section 1041. The receiving spouse can tack the transferor's ownership period for the 2-year test. If one spouse moves out but still owns the home, the remaining spouse may still qualify for the full $500,000 exclusion under the 'unforeseen circumstances' rule.