# Section 121 Exclusion: A Strategic Advantage for Homeowners
In Spring 2025, I sold one of my properties, successfully excluding $500,000 in capital gains, tax-free, due to the IRS Section 121 Exclusion. For those who may not know, this significant regulation permits homeowners to exclude as much as $250,000 in capital gains if single, or $500,000 if married filing jointly, from the sale of a primary residence—provided they satisfy the ownership and use requirements.
Fast forward to August 2025, and I’ve just been informed by my tenant that they will be vacating one of my rental properties at the end of their lease next month. Considering the San Francisco real estate market continues to remain robust, I now have a decision to make: Should I sell the property and capitalize on favorable prices? Or should I retain it, knowing that by waiting until 2027, I might exclude another $500,000 in capital gains—tax-free?
Let’s examine how the exclusion functions, how frequently you can utilize it, and why grasping this rule could save you significant amounts in taxes.
## What Is the Section 121 Exclusion?
According to [Section 121 of the IRS code](https://www.irs.gov/pub/irs-drop/rr-14-02.pdf), you can exclude up to $250,000 in capital gains ($500,000 if married filing jointly) from the sale of your primary residence, given that:
1. You’ve owned the property for a minimum of two out of the last five years, and
2. You’ve inhabited the property as your primary residence for at least two out of the last five years.
This exclusion can only be utilized **once every two years**. If you sell another home within two years of your last excluded gain, you cannot claim the exclusion again. This regulation applies not just to homes you’ve always occupied; it can also be used for properties that were previously rented, provided you meet the timing criteria.
## Why This Is Important: My March 2025 Sale
In March 2025, I sold a home where I resided from 2020 until late 2023. I vacated and rented it for around 12 months before preparing it for sale. Because I had lived in it for at least two of the last five years before the sale, I was eligible for the full $500,000 exclusion.
Assuming I bought the home for $1,000,000 and sold it for $1,800,000:
– **Total capital gain:** $800,000
– **Section 121 exclusion:** $500,000
– **Depreciation recapture:** $10,000 (taxed at 25%)
– **Remaining long-term capital gain:** $300,000
The $10,000 of depreciation recapture is *not* included in the exclusion and will be taxed at a maximum of 25%, which equals $2,500. The remaining $300,000 in capital gains will be taxed at long-term capital gains rates (which are usually 15%–20%, in addition to state taxes and possibly the 3.8% NIIT).
If I made no renovations, my total taxable gain would be $315,000, divided between depreciation recapture and standard LTCG.
Nonetheless, I saved upwards of ~$100,000 in taxes by benefiting from the exclusion.
## The New Opportunity: Rental Property Tenant Gave Notice
Now, a tenant in another one of my rental properties has just given notice. They’ve resided there since January 2020, and I haven’t lived in the property since then. Let’s say I acquired the house in 2012 for $700,000, and it is currently valued at $1.5 million.
If I sell it now, my capital gains would appear as follows:
– **Sale price:** $1,500,000
– **Original cost basis:** $700,000
– **Improvements over the years:** $50,000
– **Adjusted cost basis:** $750,000
– **Depreciation taken over rental period (5 years):** $100,000
– **Adjusted basis after depreciation:** $650,000 ($750,000 cost basis minus depreciation)
– **Capital gain:** $1,500,000 – $650,000 = $850,000
– **Depreciation recapture (taxed at 25%):** $100,000 = $25,000
– **Selling commission and transfer taxes:** $80,000
– **Remaining gain:** $670,000 (taxed at long-term cap gains rate)
Since I haven’t occupied the property for two of the last five years, I’m unable to take the Section 121 exclusion—at least not yet.
However, what if I vacate my current home and move back into this rental, which I once called home from