Home Sale Capital Gains Exclusion – Section 121

As the real estate market continues to see strong demand, this provides the perfect time to talk about the section 121 home sale capital gains exclusion.  The home sale capital gains exclusion offers one of the most significant tax benefits available.

What Exactly is The Section 121 Exclusion?

The information on home sale capital gains exclusion, full details found here at the IRS website: section 121 exclusion, allows primary residence holders to sell their property and exclude a significant amount of taxes from the gain of the sale.

Qualifications and Specifications

Single: exclude up to $250,000 in gains.

Joint Filer: exclude up to $500,000 in gains.

What do you have to do in order to obtain this tremendous tax savings?

As it lays out in the IRS guidelines, you need to be inhabiting the home for at least two of the previous five years.

This becomes especially important for anyone potentially thinking about using their property as a rental. Not being aware of this rule and timeline could cost you a lot of money.

What If You Are In The Military?

Living in San Diego, I want to point out that an appropriate adjustment exists for our military. If they’re doing a tour that pulls them out of the property, it is obviously unfair to lose that benefit. Therefore, a suspension of the rule exists for anyone on qualified extended official duty. 

How Much Could I Potentially Save?

Under normal rules, if you have gains on your property and hold it for over a year, those gains are taxed as long-term capital gains.

Example:

Let’s assume you are in the top capital gains bracket, which would be 20% on any gains.

Let’s next assume you purchase a property for $500,000 and it appreciates to $600,000 after you’ve owned it for three years. Normally, if you sell that property, you would have to pay $20,000 on that $100,000 gain ($100k x 20%).

However, if you qualify under section 121, you wouldn’t have to pay that tax and would have $20,000 more in your pocket.

Conclusion

The home sale capital gains exclusion is one of the single largest tax benefits available. As you can see, if you’re thinking of real estate as an investment opportunity, you’ll definitely want to consider your time horizon. This can be critical analysis when you’re working through your numbers. If you haven’t met the two out of five year requirement, and thinking of selling, you’ll want to make sure the investment return that you’re going to get outweighs the tax benefit that you’d otherwise receive.

If after reading this, you decide you want to move forward with your home sale, I recommend checking out this helpful Redfin article with tips on how to prepare for selling your home. 

And if you’d like to discuss your options in more detail, be sure to give us a call.