Capital Gains Exclusion Primary Residence 2026: Section 121 Rules for MLOs

Internal Revenue Code Section 121 is one of the most valuable tax provisions available to homeowners. It allows individuals and married couples to exclude a substantial amount of gain from the sale of a primary residence from federal income tax. Understanding the rules helps MLOs have more informed conversations with move-up buyers and long-term homeowners considering selling.

The Exclusion Amounts

A single filer can exclude up to $250,000 of gain from the sale of a primary residence. Married couples filing jointly can exclude up to $500,000. To qualify, the taxpayer must pass both the ownership test and the use test for the property.

The Ownership and Use Tests

The ownership test requires the taxpayer to have owned the home for at least 24 months out of the 5 years immediately preceding the sale. The use test requires that the home was used as a principal residence for at least 24 months out of the same 5-year period. The 24 months do not need to be consecutive. Both tests must be satisfied. Additionally, the exclusion cannot be used on another home sale in the prior 2 years.

• ✦Ownership test: owned for at least 24 months in the 5-year window before sale
• ✦Use test: lived in as primary residence for at least 24 months in the same 5-year window
• ✦Frequency: cannot use the exclusion more than once every 2 years
• ✦Partial exclusion: available in hardship situations including job change, health issues, or unforeseen circumstances

Gain Above the Exclusion

Gain above the Section 121 exclusion is subject to capital gains tax. If the property was held longer than one year, the gain is taxed at long-term capital gains rates of 0%, 15%, or 20% depending on the taxpayer's income. The cost basis used to calculate gain includes the original purchase price plus capital improvements made during ownership.