Homeowners who have resided in their residence for at least two of the last five years may be eligible for the Principal Residence Exclusion allowed under Section 121 of the Internal Revenue Code. Single taxpayers are entitled to a $250,000 exclusion and married taxpayers filing jointly are entitled to a $500,000 exclusion. An exclusion allows you to have a gain on the sale of your primary residence up to the maximum limit without having to pay capital gain taxes. Any gain over and above these exclusion limits is taxable.
To qualify for the exclusion, you must have lived in the property for a minimum of twenty four months during the last sixty months. The twenty four months do not have to be contiguous as the IRS allows you to aggregate your time living in the house to meet the two year residency requirement. The exclusion is available once every two years and there is no limit to the number of times you can take it. When taking the $500,000 exclusion, both spouses must meet the eligibility test and resided in the property for the full twenty four months to qualify for the full exclusion. If not, one spouse may only qualify for the exclusion.
You may be eligible for a partial exclusion when failing to meet the two year period because of special conditions, such as a change in health, employment (more than 50 miles away) or other unforeseen circumstances. Members of the military are entitled to full exclusions regardless of the length of time they resided in the property if they move to satisfy service commitments.
Section 121 as we know it today was effective May 6, 1997 and replaced (1) the old Section 121 which provided a once in a lifetime exclusion of $125,000 if you were over 55 years of age and (2) the old Section 1034 which provided a rollover provision when selling and buying a home of equal or greater value within a two year period.