IRC Section 121

Definition

IRC Section 121 provides a tax exclusion for gains from the sale of a principal residence. Specifically, it allows individuals to exclude up to $250,000 of gain ($500,000 for married couples) on the sale of their home if they meet certain ownership and use requirements. This provision is significant because it directly impacts how homeowners realize and recognize gains when selling their property.

5 Must Know Facts For Your Next Test

1. To qualify for the exclusion under IRC Section 121, taxpayers must meet the ownership test by owning the home for at least two years and the use test by living in it as their primary residence for two years within a five-year period.
2. If homeowners do not meet the criteria for full exclusion, they may still qualify for a partial exclusion under certain circumstances, such as a change in employment or health issues.
3. The gain excluded under IRC Section 121 is not subject to federal income tax, making it a significant benefit for individuals selling their homes.
4. Taxpayers can only claim the exclusion once every two years, which limits its use for frequent home sellers.
5. The exclusion applies only to gains realized on the sale of a principal residence and does not extend to second homes or investment properties.

Review Questions

• How do the ownership and use tests under IRC Section 121 determine eligibility for the exclusion when selling a home?
  • The ownership and use tests are crucial in determining eligibility for IRC Section 121's tax exclusion. To qualify, a taxpayer must have owned their home for at least two years and lived in it as their principal residence for two years during the five years prior to the sale. Meeting these criteria ensures that homeowners benefit from excluding up to $250,000 of gain ($500,000 for married couples) from their taxable income.
• Discuss how IRC Section 121 affects taxpayers who have changed jobs or experienced health issues in relation to selling their homes.
  • IRC Section 121 provides flexibility for taxpayers who have changed jobs or faced health issues by allowing them to qualify for a partial exclusion even if they do not meet the full ownership and use tests. This means that if a homeowner sells their residence due to a job relocation more than 50 miles away or due to unforeseen health problems, they can still receive a tax break on some of their capital gains. This provision supports taxpayers during significant life changes while easing their financial burdens.
• Evaluate how IRC Section 121 impacts long-term financial planning for homeowners considering selling their principal residence.
  • IRC Section 121 plays a vital role in long-term financial planning for homeowners looking to sell their principal residence. By offering a significant tax exclusion on gains from the sale, it incentivizes homeownership and encourages individuals to invest in real estate. Homeowners can strategically plan their sales around this provision, potentially deferring capital gains tax implications until they choose to sell again. Understanding this exclusion allows homeowners to maximize their profits while minimizing their tax liabilities, ultimately influencing decisions on when to sell and what properties to invest in.

Related terms

Principal Residence: A principal residence is the main home where an individual or family resides for the majority of the year and is eligible for tax benefits like exclusions under IRC Section 121.

Capital Gains Tax: A tax on the profit realized from the sale of non-inventory assets, such as stocks, bonds, or real estate, that exceeds the original purchase price.

Ownership and Use Tests: Criteria set by the IRS that individuals must meet to qualify for the exclusion under IRC Section 121, requiring that the homeowner must have owned and used the property as their principal residence for at least two out of the five years preceding the sale.