7850 / What limitations apply to a taxpayer's ability to exclude gain from the sale of a principal residence from income?

Generally, the amount of gain that may be excluded is $250,000. A taxpayer is eligible for only one maximum exclusion per principal residence.¹

Married couples may exclude up to $500,000 if: (1) they file a joint return for the taxable year of the sale; (2) either spouse meets the two-year ownership requirement (described in Q 7848); (3) both spouses meet the two-year use requirement (described in Q 7848); and (4) neither spouse is ineligible to use the exclusion as a result of having taken the exclusion in the two-year period ending on the date of the sale.²

For married taxpayers filing jointly, if either spouse does not meet the requirements described in the preceding paragraph, the maximum dollar limitation is the sum of each spouse’s limitation amount, determined on a separate basis as if the spouses had not been married. For this purpose, each spouse is treated as owning the property during the entire period that either spouse owned it.³ In other words, the full or incremental amounts of gain that would have been allowable as an exclusion to the spouses separately, if each had been single and each had owned the property throughout the period in which one spouse owned it, are added together to obtain a maximum exclusion amount.

For unmarried taxpayers who jointly own a principal residence, but file separate returns, each taxpayer may exclude up to $250,000 of gain that is attributable to each taxpayer’s interest in the property (if the requirements of IRC Section 121 have otherwise been met).⁴

Special rule for certain sales by surviving spouses. If a sale of property by a surviving spouse occurs not later than two years after the deceased spouse’s date of death, and the requirements for meeting the $500,000 exclusion (see above) were met immediately before the date of the spouse’s death, the $500,000 limit applies. This provision applies to sales or exchanges occurring after December 31, 2007.⁵