Capital Gains Tax on Home Sale: The 2026 Section 121 Exclusion

What section 121 says, test by test

The rule is often summarized as “live there 2 years.” The statute has five separate tests, and each one fails for a different kind of seller. Section 121(a) states the first two: the property “has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more” during the 5-year period ending on the date of the sale. Section 121(b)(3) adds the third, and the dollar limits of 121(b)(1) and (2) the fourth and fifth.

Three facts about who and what qualifies are easy to miss. Absences: a house you left more than a short time ago can still pass, because the use days need only fall inside the 5-year window; Treasury’s Example 1 has a seller who moved out on January 31, 1998, rented the house, and sold on April 18, 2000, and the regulation says the exclusion applies because he “has owned and used the house as his principal residence for at least 2 of the 5 years preceding the sale” (Treas. Reg. 1.121-1(c)(4)). In Example 2 the owner moved out, her son lived there, and the exclusion does not apply: the use must be the taxpayer’s own. Care facilities: a person who becomes physically or mentally incapable of self-care and who used the home as a residence for at least 1 year of the window is treated as using it while living in a facility licensed by a State or political subdivision (121(d)(7); Treas. Reg. 1.121-1(c)(2)(ii)). Title: a residence in a trust the taxpayer is treated as owning under sections 671 through 679, or in a single-owner LLC disregarded for tax, counts as the owner’s (Treas. Reg. 1.121-1(c)(3)).

Two timing points come from Publication 523 (2025, catalog 15044W, dated February 26, 2026), the edition in force for 2025 returns. The sale date is the earlier of title transfer or the shift of the economic burdens and benefits of ownership. And an individual has only one main home at a time, so a second house can pass the ownership test and fail the use test. The exclusion is elective: 121(f) says the section does not apply to a sale for which “the taxpayer elects not to have this section apply.”

The $250,000 and $500,000 have not moved since 1997

Section 121(b)(1) and (b)(2)(A) state dollar amounts, not formulas. We searched the statute text for an adjustment clause and found none (our reading), and Rev. Proc. 2025-32, the IRS notice of 2026 inflation adjustments, has no section 121 line (our search of its text). The amendment history printed at the end of the section in the 2024 U.S. Code edition (GPO) lists its latest change as Public Law 115-97 of 2017, a wording fix to the divorce-instrument definition in 121(d)(3). Public Law 119-21 of July 4, 2025 contains neither “section 121” nor “principal residence” in the text we saved (our search), so the 2025 tax law did not touch the exclusion.

What a fixed amount means is simple arithmetic on BLS data. The Consumer Price Index for all urban consumers (CPI-U, not seasonally adjusted) was 160.8 in August 1997 and 334.98 in August 2026. That is a ratio of 2.083, so the caps would be about $520,802 and $1,041,604 if they had been indexed from August 1997, and today’s $250,000 buys what $120,007 bought then (our arithmetic; script saved). This is not a prediction that Congress will index them; it is why a seller of a long-held house can have a gain above the cap without a luxury home.

Congress has a proposal in front of it, not a law. H.R. 4327, the “No Tax on Home Sales Act,” was introduced in the House on July 10, 2025 and referred to the Committee on Ways and Means. Its section 2 would amend section 121(b) by “striking paragraphs (1), (2), and (4)”, the $250,000 limit, the $500,000 joint limit and the surviving-spouse rule, leaving the other tests in place (our reading of the bill text). GovInfo’s bill-status record, last updated April 10, 2026, shows its latest action on January 21, 2026, a House member asking to be considered first sponsor, and no committee action after the referral (our reading of the action list). It has not passed either chamber. Until it does, the caps above are the law.

Fewer than two years: the partial exclusion, with the numbers

A seller who misses the 2-year test, or who used the exclusion on another sale in the last 2 years, can still get a reduced exclusion, but only if the sale is “by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances” (26 U.S.C. 121(c)(2)(B)). The ownership and use tests and the once-in-2-years bar are set aside, and the limit becomes a fraction of $250,000 (or $500,000 where that limit applies).

Treasury Regulation 1.121-3(g)(1) gives the fraction: the numerator is the shortest of the time owned in the 5-year window, the time used as the principal residence in that window, and the time since the last excluded sale, in days or months; “The denominator of the fraction is 730 days or 24 months.” Its first example is a seller who sold after 12 months because of a job change: “$125,000 of the gain (12/24 x $250,000).” Example 2 is a couple where only the husband met the 2-year test: his $250,000 plus her $125,000 (365/730) is $375,000. We ran the same formula for a job move after 14 months: 14/24 x $250,000 is $145,833 for one owner, and $291,667 for two spouses who each lived there 14 months (our arithmetic).

The reason matters more than the arithmetic. The regulation lists safe harbors, and outside them a sale qualifies only if the primary reason fits (Treas. Reg. 1.121-3(b)).

Publication 523 (2025) lists the same events for ordinary readers, and adds that a seller outside the safe harbors may still qualify on the facts: the event arose while the home was owned and used, the sale followed soon after, it could not reasonably have been anticipated at purchase, the owner had trouble paying for the home, and the home became less suitable for a specific reason.

A spouse has died: two separate rules

A short version often heard is that a survivor “gets 2 years.” The statute has two rules in two places, and they do different jobs.

• Time tacking, 121(d)(2): for an unmarried individual whose spouse is deceased on the sale date, “the period such unmarried individual owned and used such property shall include the period such deceased spouse owned and used such property before death.” Treasury Regulation 1.121-4(a) requires that the survivor has not remarried, and its example has a widow who inherited the house and sold it 17 days after the death: she met the tests because the late husband’s ownership and use counted.
• The $500,000 cap, 121(b)(4): the larger limit applies if the sale is “not later than 2 years after the date of death of such spouse” and the joint-return conditions of (b)(2)(A) were met immediately before the death. After that window, the limit is $250,000 (our reading).

A child or other heir is in a different position. Section 121 once had a paragraph (d)(11) that let the estate and heirs add the decedent’s ownership and use; it was repealed by Public Law 111-312 on December 17, 2010. An heir therefore starts from the heir’s own tests (our reading); how the heir’s basis is set at death is in our step-up in basis guide.

Rentals, home offices and depreciation: what the exclusion does not cover

The exclusion is for a home, and the statute carves out three kinds of gain. We do not repeat here the worked conversion examples already in our guide to 1031 exchanges on a primary residence; this section shows what the regulations add.

1. Nonqualified use, 121(b)(5). Gain is allocated by the ratio of the periods of nonqualified use to the whole period of ownership, and the allocated share is not excluded. A period of nonqualified use is any period “other than the portion of any period preceding January 1, 2009” when the property is not used as the principal residence of the taxpayer, spouse or former spouse. Three exceptions: the part of the 5-year window after the last day it was used as the residence, up to 10 years of qualified official extended duty, and up to 2 years of temporary absence for a job change, health or unforeseen circumstances. Publication 523’s Cartier example moved out, rented the house and sold it, and has no nonqualified use because every rental month fell after the last day of residence.
2. Depreciation, 121(d)(6) and Treas. Reg. 1.121-1(d). The exclusion “shall not apply to so much of the gain … as does not exceed the portion of the depreciation adjustments … attributable to periods after May 6, 1997.” The regulation’s example: gain $40,000, depreciation $14,000 from earlier rental, so $26,000 is excludable and $14,000 is unrecaptured section 1250 gain, taxed at up to 25% (26 U.S.C. 1(h)(1)(E)). Publication 523 adds that a seller who never deducted depreciation still reduces basis by “the amount you could have deducted.” Our depreciation recapture guide covers the rental side.
3. A separate part of the property, Treas. Reg. 1.121-1(e). If a part is used for business or rent and it is separate from the dwelling unit, gain is allocated to it; Example 3 has a basement apartment with its own entrance rented out: $6,000 of an $18,000 gain is allocated to the apartment and $12,000 is excludable. A home office inside the same dwelling unit needs no allocation; in Example 5 an attorney with a law office in her house recognizes only the $2,000 of depreciation as unrecaptured section 1250 gain and excludes the other $11,000.

Section 121(d)(10) closes one more door: no exclusion on a sale “during the 5-year period beginning with the date of such acquisition” of property acquired in a 1031 exchange. Publication 523 repeats this as an automatic disqualification.

Reporting: Form 1099-S, Form 8949 and a sale that is fully excluded

The home-sale reporting rules come from the IRS, not from section 121, and they are why a fully excluded sale can still show up on a tax return. The Instructions for Form 1099-S (Rev. 12-2026, as posted on irs.gov on October 12, 2026) say that “a sale of a main home may be a reportable sale even though the transferor may be entitled to exclude the gain under section 121.” Apart from the certification exception below, the only dollar exception in the list is a de minimis transfer for less than $600; there is no gain-based threshold.

A settlement agent can skip the form if it holds the seller’s written certification, signed under penalties of perjury by each seller, that the home is a principal residence, that the full gain is excludable under section 121, and that there was no period of nonqualified use after December 31, 2008. The sale price must be $250,000 or less, or $500,000 if the certification says the seller is married. The agent may collect the certification up to January 31 of the year after the sale, must keep it 4 years, and is not required to obtain it; without it the agent files and furnishes Form 1099-S. (This is the agent’s rule, not a seller deadline; our reading.)

For the seller, Publication 523 (2025) says you must report the sale if you have taxable gain, if you received a 1099-S (“even if you have no taxable gain to report”), or if you choose to report an excludable gain. The Form 8949 instructions work an example: sale $320,000, basis $100,000, selling expenses $20,000 not on the 1099-S, so a column (g) adjustment of -$220,000 with code EH, leaving zero gain. The same publication says to keep the records until 3 years after the due date of the return for the year of sale.

The tax on the gain above the exclusion in 2026

This page does not repeat the federal rate walk-through and the 50-state table in our capital gains on real estate guide, which also covers rental and investment property. What is specific to a home is which part of the gain reaches those rates.

Section 1(h)(1) sets the rate layers: 0, 15 and 20 percent of adjusted net capital gain, and 25 percent on unrecaptured section 1250 gain. The 2026 dollar thresholds come from Rev. Proc. 2025-32, section 4.03, and apply to taxable years beginning in 2026:

The 3.8% net investment income tax. Section 1411(a)(1) taxes 3.8 percent of the lesser of net investment income or the excess of modified adjusted gross income over $250,000 (joint return or surviving spouse) or $200,000 (other taxpayers), amounts in the statute. Net investment income includes “net gain (to the extent taken into account in computing taxable income)” from dispositions of property (1411(c)(1)(A)(iii)). Excluded home gain is not in taxable income, and the regulation says so in an example: the seller “excludes the $200,000 gain … from A's Year 1 gross income and, consequently, from A's net investment income” (Treas. Reg. 1.1411-4(d)(3)(ii), Example 3). The premise that 1411(c)(4) does this work is mistaken; that paragraph is the exception for dispositions of certain active partnership and S corporation interests.

Our arithmetic on a hypothetical, not a forecast: a single seller with a $400,000 gain and $120,000 of other income. The exclusion removes $250,000, leaving $150,000 taxable. MAGI is $270,000, which is $70,000 over $200,000, and 3.8% of the lesser of $150,000 and $70,000 is $2,660 of NIIT. A seller whose entire gain is excluded has none of this tax on it, but the 1099-S rules above still apply.

What the IRS data show: how many home sales reach a tax return

The IRS publishes one table that isolates home sales. In Table 1, “Short-Term and Long-Term Capital Gains and Losses, by Asset Type,” of its Sales of Capital Assets series, Statistics of Income (SOI) has an asset line called “Principal residences.” Its newest year is tax year 2015 (tables dated February 2022; the SOI page lists nothing newer on October 12, 2026), so it is a structural picture, not a 2026 count. The counts are transactions, estimated from a sample; money is in thousands of dollars.

Reading these numbers (shares are our arithmetic): 78.8% of the 2015 sales were reported with no gain or loss, 17.5% with a gain and 3.7% with a loss. Sales rose 37.9% from 2013 to 2015. Of the 498,538, 468,235 (93.9%) were long-term. For the 393,095 no-gain-or-loss sales, sales price was $134.55 billion and basis as reported was $113.09 billion; the $21.46 billion difference averages $54,598 a sale (our arithmetic). The table’s own footnote says that “sales of principal residences, and these transactions are not balanced,” and the Form 8949 example above shows why: the exclusion is entered as an adjustment, so the table’s basis column does not equal sales price in these rows. We read the gap as a rough indication of excluded gain on sales that reached a return, not a measure of it. The SOI has no table of the excluded amount (our search of its page), and sales without a 1099-S or taxable gain need not appear at all.

The average gain on the 87,115 sales with a gain is $89,423 (our arithmetic), which is well under the cap, so the six-figure case looks like the tail rather than the middle (our reading). For scale, the same table lists 1,282,815 sales of residential rental property in 2015.

Did the exclusion apply? A decision table

Facts and the text that governs them, not a result for any one taxpayer. “Yes” means the cited text allows it on those facts as stated.

What decides the number, and who computes it

The documents show five facts that decide a home seller's tax: the dates of purchase, residence and sale; the basis, including improvements, and the selling costs; any years of rental or business use and the depreciation taken or allowable; marital status on the sale date and any earlier excluded sale; and whether the reason for a sale under 2 years is one of the listed ones. The tax itself, for a gain in the six figures, depends on all other income of the year and on the state (our guide above has a 50-state table).

CPAs, enrolled agents and tax attorneys are the professionals who compute and prepare that figure on a return; a financial adviser may or may not prepare returns. The box below connects readers with fee-only or fee-based advisers through WiserAdvisor. We are paid if you request a match, we have not vetted any adviser, and the match is for the money decision around the sale, not for the tax computation (our reading of what the box offers).

This is analysis of public documents, not investment, legal or tax advice.

FAQ

Sources, read and saved on October 12, 2026: 26 U.S.C. 1, 121 and 1411, United States Code 2024 edition, Government Publishing Office (govinfo.gov); 26 CFR 1.121-1, 1.121-2, 1.121-3, 1.121-4 and 1.1411-4, eCFR (version of October 1, 2026, ecfr.gov); IRS Publication 523, Selling Your Home (2025, catalog 15044W, February 26, 2026); Instructions for Form 1099-S (Rev. 12-2026) and Instructions for Form 8949 (2025), irs.gov; Rev. Proc. 2025-32, irs.gov; Public Law 119-21 (govinfo.gov); H.R. 4327, 119th Congress, bill text (congress.gov) and bill status data (GovInfo BILLSTATUS); Bureau of Labor Statistics, CPI-U all items, U.S. city average, not seasonally adjusted, series CUUR0000SA0 (August 1997 and August 2026); IRS Statistics of Income, Sales of Capital Assets, Tables 1A and 1C, tax years 2013, 2014 and 2015, irs.gov/statistics. Our arithmetic is marked and its scripts are saved with the data. This is analysis of public documents, not investment, legal or tax advice.