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Capital Gains Tax on Home Sales: Complete 2026 Guide
TAX PLANNING • 20 MIN READ

Capital Gains Tax on Home Sales:
Complete 2026 Guide to IRS Rules

Selling your home? You could owe $0 in taxes—or $100,000+. Learn the IRS Section 121 exclusion, partial exclusion rules, and strategies to minimize your tax bill legally.

Editorial Team HouseQuick
Updated January 2026
38,921 readers
IRS 1040 and W-2 tax forms, close up, top down view

The Section 121 exclusion saves American homeowners billions in taxes annually—if they qualify (IRS, 2025)

$250K
Single Exclusion
$500K
Married Exclusion
2 of 5
Years Residency Rule
15-20%
Tax Rate If Not Exempt

Important Disclaimer

HouseQuick is NOT a CPA, tax advisor, attorney, or licensed financial professional. The information in this guide is for general educational purposes only and should not be considered tax, legal, or financial advice. Tax laws are complex and change frequently. Your specific situation may have unique factors that affect your tax liability. Always consult with a qualified CPA, tax professional, or attorney before making any decisions regarding taxes or the sale of your property. We make no guarantees about the accuracy, completeness, or applicability of this information to your situation.

Table of Contents

1 What Is Capital Gains Tax? 2 Section 121 Exclusion Explained 3 Ownership & Use Tests 4 Partial Exclusion Rules 5 How to Calculate Your Gain 6 Investment Property Rules 7 Tax Minimization Strategies 8 Reporting Your Sale to the IRS

Key Takeaways

  • Single filers can exclude up to $250,000 in capital gains; married couples filing jointly can exclude up to $500,000.
  • You must meet the ownership and use tests: own the home for 2+ years AND live in it as your primary residence for 2+ years out of the last 5 years.
  • Partial exclusions are available if you sell early due to work relocation, health issues, or unforeseen circumstances.
  • Investment properties don't qualify for the Section 121 exclusion—but 1031 exchanges can defer taxes.
  • Capital improvements (roof, additions, HVAC) increase your cost basis and reduce taxable gain.

1 What Is Capital Gains Tax on Real Estate?

Capital gains tax is the tax you pay on the profit from selling an asset—including your home. If you sell your house for more than you paid (plus improvements), that profit is potentially taxable. However, the IRS provides generous exemptions for primary residences that can eliminate or significantly reduce your tax bill.

Quick Example: Capital Gains Calculation

Purchase Price $200,000
+ Improvements $50,000
Sale Price $450,000
Capital Gain $200,000

Short-Term vs. Long-Term Capital Gains Rates (2026)

The tax rate you pay depends on how long you owned the property:

Holding Period Tax Rate Notes
Short-Term (≤1 year) 10-37% Taxed as ordinary income
Long-Term (>1 year) 0-20% Preferential rates based on income

2026 Long-Term Capital Gains Tax Brackets

Tax Rate Single Filers Married Filing Jointly
0% Up to $47,025 Up to $94,050
15% $47,026 - $518,900 $94,051 - $583,750
20% Over $518,900 Over $583,750

Don't Forget the NIIT (Net Investment Income Tax)

High earners may also owe an additional 3.8% Net Investment Income Tax on capital gains if your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). This brings the maximum effective rate to 23.8% for the highest earners.

2 IRS Section 121 Exclusion: Your Tax-Free Ticket

Section 121 of the Internal Revenue Code is the reason most homeowners pay little to no capital gains tax when selling their primary residence. It allows you to exclude a substantial portion of your profit from taxation—completely legally.

Maximum Exclusion Amounts

$250,000 Single Filers

Or married filing separately (if spouse didn't use exclusion)

$500,000 Married Filing Jointly

Both spouses must meet use test; only one needs ownership test

"The Section 121 exclusion is one of the most generous tax benefits in the entire tax code. A married couple could sell a home with $500,000 in profit and owe absolutely nothing in federal taxes—that's potentially saving over $100,000 in capital gains tax."

— Tax Planning Analysis, HouseQuick

3 The Ownership and Use Tests: Qualifying for the Exclusion

To claim the full Section 121 exclusion, you must pass two tests during the 5-year period ending on the date of sale:

1. Ownership Test

You must have owned the home for at least 2 years (730 days) during the 5-year period before the sale.

The 2 years do NOT need to be consecutive.

2. Use Test

You must have lived in the home as your primary residence for at least 2 years (730 days) during the 5-year period.

The 2 years do NOT need to be consecutive.

Visual Timeline Examples

Example 1: QUALIFIES for Full Exclusion

Purchased Jan 2021
Lived In Jan 2021 - Dec 2024
Sold Jan 2026

✓ Owned 5 years, lived in 4 years. Exceeds both requirements.

Example 2: QUALIFIES (Non-Consecutive Use)

Owned 2020-2026
Lived In 2020-2021, then 2024-2025
Rented Out 2022-2023

✓ Lived in home 4 total years (non-consecutive). Renting in between is fine!

Example 3: DOES NOT QUALIFY

Purchased Jan 2025
Lived In Jan 2025 - Jan 2026
Sold Jan 2026

✗ Only owned and lived in for 1 year. Needs 2 years minimum for each test.

Special Rules for Married Couples

  • To claim $500K exclusion: Only one spouse needs to pass the ownership test, but both must pass the use test.
  • Neither spouse can have used the exclusion in the past 2 years.
  • If only one spouse meets both tests, you can still claim up to $250K (the single filer amount).

4 Partial Exclusion: Selling Early Due to Life Circumstances

Don't meet the full 2-year requirement? You may still qualify for a partial exclusion if you sold due to work, health, or unforeseen circumstances. The IRS recognizes that life happens and provides safe harbors for early sellers.

Qualifying Events for Partial Exclusion

Work-Related
  • • New job location 50+ miles away
  • • Employer-mandated relocation
  • • Self-employment opportunity
Health-Related
  • • Doctor-recommended relocation
  • • Caring for sick family member
  • • Disability requiring new home
Unforeseen Circumstances
  • • Divorce or legal separation
  • • Death of spouse
  • • Natural disaster damage
  • • Job loss/financial hardship

How to Calculate Your Partial Exclusion

The partial exclusion is calculated based on the proportion of the 2-year requirement you met:

Partial Exclusion Formula
Partial Exclusion = (Days of Use ÷ 730 days) × Maximum Exclusion

Example: Partial Exclusion Calculation

Scenario: Sarah (single) bought a home and lived there for 18 months before relocating for a new job 60 miles away. She had a $150,000 gain.

Calculation:
  • Days lived: 548 (18 months)
  • Required days: 730 (2 years)
  • Ratio: 548 ÷ 730 = 0.75
  • Max exclusion: $250,000
Result:
  • Partial exclusion: $250,000 × 0.75 = $187,500
  • Gain: $150,000
  • Taxable: $0

Sarah owes ZERO capital gains tax because her gain is less than her partial exclusion!

5 How to Calculate Your Capital Gain (Basis Explained)

Your capital gain isn't simply the sale price minus what you paid. You need to calculate your adjusted basis—which includes improvements and certain costs that reduce your taxable gain.

Capital Gain Formula

Sale Price $500,000
−
Selling Costs $35,000
−
Adjusted Basis $280,000
=
Capital Gain $185,000

What Adds to Your Basis (Reduces Taxable Gain)

Costs That INCREASE Basis

  • Purchase costs: Closing costs, title insurance, legal fees
  • Capital improvements: New roof, HVAC, additions, kitchen remodel
  • Special assessments: Sidewalks, sewer, street improvements
  • Energy credits: Solar panels, insulation (special rules)

Costs That DO NOT Increase Basis

  • Repairs/maintenance: Painting, fixing leaks, patching
  • Operating costs: Utilities, insurance, property taxes
  • Mortgage interest: Already deducted annually
  • HOA fees: Operating expenses, not capital

Pro Tip: Keep Every Receipt!

The IRS can ask for proof of basis adjustments at any time. Keep receipts for all capital improvements in a dedicated folder—contractors' invoices, permits, material receipts. If you can't prove an improvement, you can't add it to basis. Digital copies are perfectly acceptable; just make sure they're backed up.

6 Investment Property: Different Rules Apply

If you're selling a rental property, vacation home, or property that was never your primary residence, the Section 121 exclusion does not apply. You'll owe capital gains tax on the full profit—but there are strategies to minimize or defer taxes.

Investment Property Tax Reality

Investment properties are subject to TWO types of tax:

1. Capital Gains Tax 15-20% on the appreciation (plus potential 3.8% NIIT)
2. Depreciation Recapture 25% on depreciation claimed while renting

1031 Exchange: Defer Taxes Indefinitely

A 1031 exchange (named after IRC Section 1031) allows you to sell an investment property and defer ALL capital gains taxes by reinvesting in a "like-kind" property. You don't eliminate the tax—you postpone it until you eventually sell without exchanging.

1031 Exchange Requirements

45-Day Rule: Identify replacement property within 45 days of sale
180-Day Rule: Close on replacement within 180 days
Equal or Greater: Replacement must be same or higher value
Qualified Intermediary: Must use third-party to hold funds

Converting Investment to Primary Residence

Can you convert a rental to your primary residence and claim the Section 121 exclusion? Yes, but with limits.

The "Non-Qualified Use" Rule

If you convert a rental to your primary residence, a portion of your gain will NOT be excludable—the portion attributable to "non-qualified use" (the time it was a rental after 2008).

Example:
  • • Owned property 10 years total
  • • Rented first 6 years, lived in last 4 years
  • • 60% of gain is "non-qualified use" (still taxable)
  • • Only 40% of gain can be excluded

7 Tax Minimization Strategies

Even if you can't avoid capital gains entirely, these strategies can help minimize your tax bill:

1 Time Your Sale for a Low-Income Year

If your income will be lower next year (retirement, job change, sabbatical), consider waiting. Lower income = lower tax bracket = potential 0% rate on capital gains.

2 Maximize Your Basis with Documentation

Review all home improvements you've made. That kitchen remodel, new roof, HVAC replacement, landscaping—all add to basis. Don't leave money on the table.

3 Offset Gains with Losses (Tax-Loss Harvesting)

Capital losses from stocks, bonds, or other investments can offset real estate gains. If you have losing investments, consider selling them the same year.

4 Installment Sale for Large Gains

Instead of receiving all proceeds at once, an installment sale spreads payments (and taxes) over multiple years. This can keep you in lower brackets each year.

5 Opportunity Zone Investment

Reinvest capital gains into a Qualified Opportunity Zone Fund within 180 days to defer and potentially reduce taxes. Hold for 10+ years and pay zero tax on NEW appreciation.

8 Reporting Your Home Sale to the IRS

Here's the good news: if you meet the full Section 121 exclusion and your gain is fully excluded, you don't have to report the sale to the IRS at all. However, there are situations where reporting is required.

When Must You Report the Sale?

NO Reporting Required If:
  • You meet full ownership AND use tests
  • Gain is ≤ $250K (single) or $500K (married)
  • Haven't used exclusion in past 2 years
  • Didn't receive Form 1099-S
MUST Report If:
  • Gain exceeds exclusion amount
  • You received Form 1099-S
  • You elect NOT to claim exclusion
  • Property was partially business use

How to Report: IRS Forms

Schedule D (Form 1040)

Report capital gains and losses. This is where your home sale profit flows to your main tax return.

Form 8949

Sales and Other Dispositions of Capital Assets. Provides detail on each asset sold, including your home.

Form 1099-S

You'll receive this from the closing agent if proceeds exceed $250K. Even if exclusion covers gain, you must report when you receive a 1099-S.

Consult a Tax Professional

While this guide provides comprehensive information, tax situations vary. If you have a complex sale (partial business use, rental conversion, 1031 exchange), or if your gain exceeds exclusion limits, we strongly recommend consulting a CPA or tax attorney. The cost of professional advice is often far less than tax mistakes.

Frequently Asked Questions

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About This Guide

This capital gains tax guide was created by the HouseQuick editorial team in consultation with tax professionals. While comprehensive, this guide is for educational purposes—consult a CPA for your specific situation.

Sources & References:
  • • IRS Publication 523 - Selling Your Home (2025)
  • • Internal Revenue Code Section 121
  • • IRS Topic No. 409 - Capital Gains and Losses
  • • IRS Publication 544 - Sales and Other Dispositions of Assets
  • • Tax Policy Center - Capital Gains Tax Analysis

Last updated: January 2026 • Reading time: ~20 minutes • Back to Blog