Multiple Parties Can Exclude Capital Gains Upon the Sale of Their Primary Residence

When selling a primary residence, many taxpayers benefit from the capital gains exclusion under Section 121 of the Internal Revenue Code. This provision allows individuals to exclude up to $250,000 of gain ($500,000 for certain married couples filing jointly) from taxable income, provided specific ownership and use tests are met.

What some property owners may not realize is that, in certain cases, multiple parties who co-own a property can each potentially claim the exclusion, depending on their circumstances. Treasury Regulations, particularly Section 1.121, provide further clarity on how this applies in real-world situations.

The Basics of Section 121 Exclusion

To qualify for the exclusion, a taxpayer must generally:

• Have owned the residence for at least two years during the five years preceding the sale.

• Have used the property as their primary residence for at least two years during the same five-year period.

• Not have claimed a Section 121 exclusion for another property sale within the past two years.

How Multiple Owners Can Each Benefit

When two or more individuals co-own a primary residence, each owner’s eligibility is determined separately. This means that, if the requirements are met, each qualifying co-owner may exclude up to $250,000 of gain from their individual tax liability.

Example:

• Two unrelated friends purchase a home together and live in it as their primary residence.

• Both meet the two-year ownership and use tests.

• Upon selling the property, each owner may exclude up to $250,000 of gain, for a potential combined exclusion of $500,000—even though they are not married.

Married Couples and the $500,000 Exclusion

For married taxpayers filing jointly, the maximum exclusion is $500,000 if:

• Either spouse meets the ownership requirement, and

• Both spouses meet the use requirement.

If only one spouse meets the use requirement, the couple may still qualify for a partial exclusion.

Situations Where Partial Exclusions May Apply

Section 121 also allows for a prorated exclusion if a sale occurs before the two-year period is satisfied due to specific circumstances, such as:

• Change in employment,

• Health-related reasons, or

• Other unforeseen circumstances (as defined by IRS regulations).

The combination of Section 121 of the Internal Revenue Code and Treasury Regulation 1.121 provides flexibility for taxpayers who own homes together, whether married or not. Understanding how these rules apply can result in substantial tax savings when selling a primary residence.