IRS Section 121: How to Calculate Capital Gains on a Home Sale

To qualify for the Section 121 exclusion, you must satisfy two statutory rules during the 5-year window ending on the date of sale: 1. Ownership Test: You owned the home for at least 24 months (730 days). 2. Use Test: The home was your primary residence for at least 24 months. Married couples filing jointly qualify for the full $500,000 exemption if either spouse meets the ownership requirement and both spouses meet the residency use test.

Your net capital gain is calculated as: Net Capital Gain = (Final Selling Price - Closing Costs) - Adjusted Cost Basis Your Adjusted Cost Basis starts with your original purchase price + purchase closing costs (title insurance, transfer taxes). You then add the documented cost of all permanent capital improvements made during your ownership period.

Not all home expenses increase your basis. The IRS strictly distinguishes between: • Capital Improvements (Adds to Basis): Work that prolongs the useful life of the property, adapts it to new uses, or materially enhances its structural value (e.g. replacing a roof, complete electrical rewire, new HVAC heat pump, kitchen remodel). • Routine Repairs (Disallowed for Basis): Routine maintenance that simply preserves the property in normal operating condition (e.g. repainting a room, fixing a leaky faucet, patching a shingle). On primary residences, repair costs cannot be added to basis.