How Home Sales Are Taxed: The $250,000/$500,000 Exclusion Explained

Linda and Tom bought their house in 2006 for $280,000. Over the years they added a new roof, a kitchen, and a primary suite, about $60,000 in improvements. Now their kids are grown, and an agent tells them the house should sell for about $1.05 million. Their first question is the one most long-time owners ask: how much of that will go to taxes?

The answer depends on Section 121 of the tax code, the home sale exclusion. It lets a single filer exclude up to $250,000 of gain on the sale of a main home, and a married couple filing jointly up to $500,000, if they meet the ownership and use tests. Linda and Tom will owe tax on part of their gain, but far less than they fear. Below, we work through their numbers and then the fine print that trips up sellers most often.

Has any recent law changed the $250,000 and $500,000 limits?

No. The amounts have stayed the same since the exclusion was created by the Taxpayer Relief Act of 1997, and they are not adjusted for inflation. The One Big Beautiful Bill Act, signed in July 2025, did not change them. A bill called the No Tax on Home Sales Act, H.R. 4327, would remove the dollar caps entirely, but as of early October 2026 it had not moved past the House Ways and Means Committee, according to Congress.gov. Until a change actually becomes law, plan around $250,000 and $500,000.

How the exclusion works

According to IRS Publication 523, you generally qualify for the full exclusion if three things are true. You owned the home for at least 24 months during the five years ending on the date of sale. You lived in it as your main home for at least 24 months during that same five-year window. And you did not exclude gain from another home sale during the two years before this one.

For the $500,000 joint exclusion, only one spouse has to meet the ownership test, but both must meet the use test, and neither can have used the exclusion within the prior two years. If only one spouse qualifies, the couple can usually still exclude up to $250,000 for that spouse's share.

Linda and Tom's numbers

Gain is not simply sale price minus purchase price. Start with the amount realized: the $1,050,000 sale price minus selling costs such as commissions and title fees, which we will estimate at $55,000. That leaves $995,000.

Next, figure the adjusted basis: the $280,000 purchase price plus certain closing costs from the purchase and the $60,000 of improvements, for at least $340,000. Repairs and routine maintenance do not count, but improvements that add value or extend the home's life do.

Their gain is about $655,000. As a married couple filing jointly who both lived there for decades, they can exclude $500,000. The remaining $155,000 is a long-term capital gain, taxed at 0%, 15%, or 20% depending on their income, and it may also count toward the 3.8% net investment income tax if their modified AGI is high enough. Without the improvement records, their taxable gain would have been $60,000 higher, which is why the receipts in the kitchen drawer matter.

Myth: You must buy another home to avoid the tax

This was true under the old rollover rules, which required you to buy a replacement home of equal or greater value to defer the gain. Those rules were replaced in 1997. Today, the exclusion applies whether you buy a bigger home, downsize, rent, or move into a retirement community. What you do with the proceeds does not matter.

Myth: It's a once-in-a-lifetime break

That describes an older rule that gave a one-time exclusion to sellers 55 and older. Under current law, you can use the exclusion repeatedly, as often as once every two years, as long as you meet the ownership and use tests each time. There is no age requirement.

Myth: The two years have to be continuous and recent

Not so. The 24 months of residence can fall anywhere in the five-year period before the sale, and Publication 523 notes they do not have to be one continuous block. Living there for 730 days in total over the five years is enough. That flexibility helps people who move out a year before selling, or who split time between homes, as long as the house was their main home during the qualifying days. Short temporary absences, such as vacations, generally count as time living there.

Myth: If you don't meet the two-year tests, you get nothing

You may still get a partial exclusion if you sold primarily because of a change in work location, a health issue, or certain unforeseen circumstances. Publication 523 lists events such as a work-related move, a health-related move, a death, a divorce, a pregnancy with multiple children, a change in employment status, and a change in unemployment compensation eligibility. For a work move, a common safe harbor is a new job location at least 50 miles farther from the home than the old one.

The partial exclusion is prorated. Take the shortest of the time you owned the home, the time you lived in it as your main home, or the time since you last used the exclusion, and divide by 24 months. A single filer who lived in a home for 12 months before relocating for a new job could exclude up to 12 divided by 24 of $250,000, or $125,000. That is a cap on the exclusion, not a fraction of the gain, so a modest gain may still be fully covered.

Myth: Years you rented the home out don't matter if you lived there two years

This is the fine print that catches landlords and people who convert rentals into their homes. Since 2009, gain allocated to periods of "nonqualified use" generally cannot be excluded. Nonqualified use is generally any time after 2008 when the home was not your main home, such as when it was a rental or a second home.

Here is an example. Priya buys a property on January 1, 2020, rents it out for two years, then moves in on January 1, 2022, and lives there until she sells on December 31, 2026. She owned it for seven years, two of them nonqualified use. Suppose her gain is $210,000, of which $20,000 reflects depreciation she claimed while renting. Depreciation is handled separately, as explained below, so the remaining $190,000 is allocated: two-sevenths, about $54,300, is tied to nonqualified use and taxable. The rest, about $135,700, can be excluded.

Two exceptions matter. Time after you move out of your main home, within the five-year window before the sale, is not counted as nonqualified use. That protects people who move out and then sell or rent the home for up to three years. Certain temporary absences and qualified military or government duty are also excluded from nonqualified use.

Myth: Depreciation disappears when the exclusion applies

If you claimed, or were entitled to claim, depreciation for a home office or a rental period after May 6, 1997, that portion of the gain cannot be excluded. Publication 523 says it must be recaptured. It is generally taxed as unrecaptured Section 1250 gain at a maximum federal rate of 25%. In Priya's case, her $20,000 of depreciation is taxable even though most of her other gain is excluded.

Home offices inside the living area of the home do not have to be split off for purposes of the exclusion, but the depreciation rule still applies to them. If you take the home office deduction using actual expenses and depreciation, keep track of it for the day you sell.

Myth: Your basis is just what you paid

Your basis starts with the purchase price, but it usually grows. Many settlement costs from the purchase can be added, such as title insurance, recording fees, transfer taxes, and legal fees, though costs tied to getting the mortgage generally cannot. Capital improvements add to basis too: additions, a new roof, new windows, a remodeled kitchen, central air, landscaping, and similar projects that add value or prolong the home's life. Routine repairs and painting usually do not.

Basis can also go down. If you claimed certain energy credits for improvements, received certain subsidies, or deducted a casualty loss, Publication 523 explains how those can reduce your basis. Depreciation claimed for a home office or rental reduces it as well.

For sellers near or above the exclusion limit, every documented dollar of basis is a dollar less of taxable gain. If you are missing records, contractor invoices, permit records from your city, credit card statements, and old photos can help reconstruct the history.

Myth: A loss on your home is deductible

A loss on the sale of a personal residence is not deductible. If prices have fallen since you bought, the exclusion simply does not come into play, and there is no write-off. Only the portion of a home that was used as a rental or business may produce a deductible loss, and that requires its own calculation.

Myth: If all the gain is excluded, there's nothing to report

Often true, but not always. If your entire gain is excludable and you did not receive Form 1099-S from the closing agent, you generally do not need to report the sale. If you received a Form 1099-S, you must report the sale even if all of the gain is excluded, using Form 8949 and Schedule D. You must also report it if any of the gain is taxable, including depreciation recapture.

Special situations worth knowing

Surviving spouses. A widow or widower who has not remarried can claim the full $500,000 exclusion if the home is sold within two years of the spouse's death and the joint requirements were met just before the death. That two-year window matters for timing a sale.

Military and certain government service. Members of the uniformed services, Foreign Service, intelligence community, and Peace Corps on qualified official extended duty can elect to suspend the five-year test period for up to 10 years.

Divorce. A spouse who keeps living in the home can let the other spouse count that time toward the use test if the home is used under a divorce or separation instrument. Transfers between spouses incident to divorce generally do not trigger gain.

Inherited homes. Heirs generally receive a basis equal to the home's fair market value at the date of death, which can wipe out decades of appreciation, and they may not need the exclusion at all.

This article is general education, not tax advice. State income tax rules on home sales may differ from federal law, so check your state's treatment too.

The bottom line

Most homeowners who have lived in their home for two of the last five years will owe nothing, and those with large gains will owe tax only on the excess. Before you list, add up your basis with every improvement receipt you can find, and run the numbers on any rental years, home office depreciation, or partial-exclusion event with a tax professional.