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Quick Facts

• Section 121 allows homeowners to exclude up to $250,000 of capital gain from the sale of a primary residence from federal income tax. Married couples filing jointly may exclude up to $500,000.
• These limits have not been adjusted since 1997. As home values have appreciated over the past three decades, more homeowners are finding that careful basis calculation and planning can materially affect the amount of gain subject to tax.
• Texas has no state income tax. Capital gains from a home sale are subject to federal tax only.

Special rules apply in divorce, for surviving spouses, and for military service members. See below.

What Is the Section 121 Home Sale Exclusion and Who Qualifies?

Section 121 of the Internal Revenue Code is one of the most valuable provisions in the federal tax code for individual taxpayers. It allows a homeowner to exclude a significant portion of the profit from the sale of their primary residence from federal income tax entirely. Most people searching for this topic know it as the home sale tax exclusion or capital gains exclusion on a home sale.

The exclusion amounts for 2026 are $250,000 for single filers and $500,000 for married couples filing jointly. These limits have not changed since the Taxpayer Relief Act of 1997. As home values have appreciated over the past three decades, more homeowners are finding that careful basis calculation and planning can materially affect the amount of gain subject to tax.

To qualify, you must meet both of the following tests during the five-year period ending on the date of the sale:

• Ownership test: You must have owned the home for at least two years out of the last five.
• Use test: You must have used the home as your primary residence for at least two years out of the last five.

The two years do not need to be continuous, and you do not need to be living in the home on the date of the sale. There are no income limits for the Section 121 exclusion.

Practical note: If you receive a Form 1099-S from the title company or closing agent, you must report the sale on your tax return even if the gain is fully excluded. Confirm with your tax advisor.

Does Your Home Sale Qualify? A Step-by-Step Guide

How Is Capital Gain Calculated on a Home Sale?

Your gain is not simply the difference between what you paid and what you sold for. It is the difference between your amount realized and your adjusted tax basis. Getting this calculation right can significantly reduce your taxable gain, and many homeowners leave money on the table by underestimating their basis.

What Is Your Amount Realized?

The amount realized is your sale price minus your selling expenses. Selling expenses include real estate commissions, attorney fees, title fees, transfer taxes, and other costs directly related to the sale. These reduce your taxable gain dollar for dollar.

What Is Your Tax Basis?

Your tax basis starts with what you paid for the home at purchase, plus certain closing costs from that original transaction. It is then increased by the cost of capital improvements made during your ownership and decreased by any depreciation previously claimed for rental or business use.

Capital improvements are additions or upgrades that add value, extend the home’s useful life, or adapt it to a new use. Routine repairs and maintenance do not increase basis. One of the most commonly missed basis items is the purchase closing costs from the original settlement statement. If you no longer have your closing documents, your title company or county clerk’s office can provide a copy.

Commonly Missed Basis Items

Many homeowners underestimate their basis simply because they did not know these items qualify. Each one reduces your taxable gain dollar for dollar at sale.

• Original title insurance (buyer’s portion paid at closing)
• Recording fees paid at original closing
• Transfer taxes paid by the buyer at closing
• Legal fees for title search and contract preparation
• Roof replacement
• HVAC system replacement
• Room additions
• Major kitchen or bathroom remodel
• Permanent landscaping (driveways, fences, retaining walls)
• Electrical or plumbing system upgrades
• Insulation installation or upgrades

What Counts Toward Your Tax Basis?

A quick reference: improvements vs. maintenance

How Gain Is Calculated: An Illustration

Sale price	$650,000
Selling expenses (commissions, fees)	($26,000)
Amount realized	$624,000
Original purchase price	$280,000
Purchase closing costs added to basis	$8,500
Capital improvements during ownership	$42,000
Tax basis	($330,500)
Total gain before exclusion	$293,500
Section 121 exclusion (married filing jointly)	($293,500)
Taxable gain	$0

For illustrative purposes only. Individual results will vary. Consult your tax advisor for your specific situation.

For a detailed breakdown of how improvements, selling costs, and depreciation recapture interact when a property has been used as a rental before conversion to a primary residence, see the companion post: Should You Convert Your Rental Property to a Primary Residence Before Selling? [link coming soon]

What Special Situations Affect the Section 121 Exclusion?

Divorce

Divorce introduces Section 121 rules around ownership periods, use credit for time away, and sale timing that can be worth up to $250,000 in additional exclusion depending on when the home is sold relative to when the decree is final. These rules are covered in full in the companion post: When One Spouse Wants to Keep the House: What to Know Before the Divorce Is Final

Surviving Spouse

This is one of the most important and underknown provisions in Section 121. Under IRC Section 121(b)(4), a surviving spouse who has not remarried may claim the full $500,000 exclusion if the sale occurs within two years of the date of the spouse’s death, provided the married filing jointly requirements were met immediately before the death.

After the two-year window closes, or if the surviving spouse remarries before selling, the exclusion reverts to the individual $250,000 limit. For a widowed homeowner with significant appreciation, the difference between selling within that window and waiting can be substantial. This is a planning decision that deserves attention before the grief and logistics of settling an estate cause the window to quietly pass.

Surviving spouse rule: The full $500,000 exclusion is available if the home is sold within two years of the spouse’s death and the MFJ requirements were met immediately before death. After that window, the limit drops to $250,000. Source: IRC Section 121(b)(4).

Military Service, Foreign Service, and Peace Corps

Members of the uniformed services, the Foreign Service, and the intelligence community on qualified official extended duty may elect to suspend the five-year ownership and use test clock for up to 10 years. To qualify, the duty assignment must be at a station at least 50 miles from the home, or the member must be living in government quarters under orders, and the service must exceed 90 days or be for an indefinite period.

Together, the 10-year suspension and the five-year test period can span no more than 15 years in total. The suspension can only apply to one property at a time. Peace Corps volunteers serving outside the United States qualify for the same suspension. Military families in the Bryan-College Station area, particularly those with ties to Fort Cavazos, should verify eligibility with a tax advisor before assuming the exclusion is unavailable due to extended time away.

What If You Need to Sell Before Meeting the Two-Year Requirement?

If you have not yet met the full two-year ownership and use tests, you may still qualify for a partial exclusion if the sale is driven by one of three qualifying reasons:

• A change in place of employment, where the new workplace is at least 50 miles farther from the home than the prior workplace.
• A health-related move, supported by a physician’s recommendation to relocate for treatment or to care for a family member.
• Unforeseen circumstances, which the IRS has defined to include divorce or legal separation, death of a co-owner, involuntary conversion such as destruction or condemnation, and certain other qualifying events.

Partial Exclusion Formula: Maximum Exclusion x (Qualifying Months / 24) Example: Single filer, 18 months of qualifying use, qualifying reason applies $250,000 x (18 / 24) = $187,500 partial exclusion

What Happens to Gain That Exceeds the Exclusion?

Gain above the exclusion limit is generally taxed at long-term capital gains rates if you have owned the home for more than one year. For 2026, the rates and thresholds confirmed by IRS Revenue Procedure 2025-32 are as follows.

 

Taxable Gain Scenario	Tax Rate	2026 Threshold Notes
Long-term gain, lower income bracket	0%	Up to $49,450 taxable income (single) / $98,900 (MFJ). Source: Rev. Proc. 2025-32
Long-term gain, middle income bracket	15%	Applies to most sellers. Up to $545,500 single / $613,700 MFJ
Long-term gain, higher income bracket	20%	Applies above the 15% threshold
Net Investment Income Tax (NIIT)	3.8%	Stacks on top above $200K single / $250K MFJ MAGI. Not inflation-adjusted since 2013.
Depreciation recapture (Section 1250)	Up to 25%	Taxed as ordinary income. Cannot be excluded. Applies to prior rental or home office depreciation.

Source: IRS Revenue Procedure 2025-32. Thresholds are based on taxable income after deductions. Consult your tax advisor for your specific situation.

For sellers with gain above the exclusion, spreading the sale proceeds over multiple years through an installment sale may keep annual taxable income below higher brackets and the NIIT threshold. Discuss this strategy with your CPA before closing.

What Do Texas Homeowners Specifically Need to Know?

Texas has no state income tax, which means capital gains from a home sale are subject only to federal tax. Texas is also a community property state, which means equity built up in the family home during a marriage is generally considered jointly owned regardless of whose name is on the deed.

A Note on Agricultural Valuation and Rollback Taxes

For Texas homeowners whose property has been receiving an agricultural use valuation, a sale or change of use can trigger a rollback tax reaching back five years, plus 7% annual interest per year. This is a county-level property tax obligation, entirely separate from the federal Section 121 treatment. A seller can qualify for the full Section 121 exclusion on the federal gain and still owe a significant rollback tax at the county level. Verify exposure with your county appraisal district and a Texas real estate attorney before listing.

What Should You Do Before Listing Your Home?

• Have you owned and lived in the home for at least two of the last five years?
• Do you know your tax basis, including capital improvements and original closing costs?
• Has any portion of the home been used for rental or business purposes that may require depreciation recapture?
• Is your estimated gain above the exclusion limit, and if so, by how much?
• Does the timing of the sale affect which exclusion amount is available (married vs. single, or within the surviving spouse two-year window)?
• If your property has an agricultural valuation, have you verified the rollback tax exposure with your county appraisal district?
• If you or your spouse are on military service, have you verified whether the five-year test clock suspension applies?

Frequently Asked Questions

What is the Section 121 home sale exclusion?

Section 121 allows a homeowner to exclude up to $250,000 of capital gain from the sale of a primary residence from federal income tax. Married couples filing jointly may exclude up to $500,000. To qualify, you must have owned and used the home as your primary residence for at least two of the five years before the sale date. There are no income limits. These thresholds have not been adjusted since 1997.

Do the two years of ownership and use have to be continuous?

No. The two years of ownership and the two years of use do not need to be continuous, and they do not need to overlap with each other. Both must be met within the five-year window ending on the sale date.

How is tax basis calculated for a home sale?

Tax basis starts with your original purchase price plus qualifying closing costs from acquisition. It increases with the cost of capital improvements and decreases by any depreciation previously claimed for rental or business use. Selling expenses at closing also reduce your amount realized, which reduces your taxable gain.

What happens if my gain exceeds the Section 121 exclusion?

Gain above the exclusion is generally taxed at long-term capital gains rates of 0%, 15%, or 20% depending on your taxable income. The 0% rate applies up to $49,450 for single filers and $98,900 for married filing jointly in 2026. The Net Investment Income Tax of 3.8% may also apply. Previously claimed depreciation is taxed at up to 25% regardless of the exclusion.

Can I use the Section 121 exclusion more than once?

Yes, but generally not more than once every two years. If you used the exclusion on a prior home sale within the last 24 months, you may be limited unless a partial exclusion exception applies.

What is the Section 121 exclusion for a surviving spouse?

Under IRC Section 121(b)(4), a surviving spouse who has not remarried may claim the full $500,000 exclusion if the sale occurs within two years of the date of the spouse’s death, provided the married filing jointly requirements were met immediately before the death. After that window, or if the surviving spouse remarries before selling, the exclusion reverts to $250,000.

What if I need to sell before living in the home for two years?

A partial exclusion may be available if the early sale is driven by a job relocation of at least 50 miles, a qualifying health reason, or an unforeseen circumstance such as a divorce. The partial exclusion is prorated based on how many months you met the ownership and use tests out of the required 24.

Are there special rules for divorce or military service?

Yes. Divorce introduces rules around ownership period inheritance, use credit, and sale timing that can significantly affect the available exclusion. Military members on qualified extended duty may suspend the five-year test clock for up to 10 years. Both situations are covered in the companion posts linked below.

Does Texas have a state tax on home sale gains?

No. Texas has no state income tax, which means capital gains from a home sale are subject only to federal tax.

Do I need to report a home sale if all the gain is excluded?

Not always, but if you received a Form 1099-S from the title company or closing agent, you are required to report the sale on your return even if the gain is fully excluded. When in doubt, report it and show zero taxable gain on Form 8949. Confirm with your tax advisor.

These questions do not require an attorney to answer. They require a financial planner who can model the numbers before the listing goes live and ensure the after-tax outcome matches the intent of the transaction.

If you are considering a sale and want to understand what the after-tax picture actually looks like for your situation, that is exactly the kind of conversation I am here for.

Planning with Purpose. Growing with Grace.

This post is part of the Core Financial Planning series on theerskinegroup.net. Related posts: When One Spouse Wants to Keep the House: What to Know Before the Divorce Is Final What Is a QDRO and Why Does It Matter in a Divorce? Should You Use Retirement Assets to Get Out of Debt Before 59½? Should You Convert Your Rental Property to a Primary Residence Before Selling? [link coming soon]

Sources

• Internal Revenue Code Section 121, Exclusion of Gain from Sale of Principal Residence
• IRS Publication 523, Selling Your Home (2025)
• IRS Publication 3, Armed Forces Tax Guide (2025)
• IRS Topic No. 701, Sale of Your Home
• IRS Revenue Procedure 2025-32, 2026 Long-Term Capital Gains Tax Thresholds
• 26 CFR Section 1.121-4, Special Rules (Ownership and Use Test, Divorce)
• 26 CFR Section 1.121-5, Suspension of 5-Year Period for Uniformed Services and Foreign Service
• Texas Property Tax Code Section 23.46, Rollback Tax on Change of Agricultural Use
• Texas Family Code Chapter 7, Division of Marital Property

Securities and advisory services offered through LPL Financial, a registered investment advisor, member FINRA/SIPC. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. This information is not intended to be a substitute for individualized tax or legal advice. Please consult your tax advisor and attorney regarding your specific situation. Investing involves risk, including possible loss of principal.