For the 2025 U.S. federal tax year, a single taxpayer sells their main home for a gain. During the 5-year period ending on the date of sale, the taxpayer owned the home for 3 years but lived in it as a principal residence for only 18 months, then rented it out to a tenant for the remaining time before selling. Under IRC Section 121, can the taxpayer exclude any of the gain from income?
- Yes, the full $250,000 exclusion is available because the taxpayer met the ownership test, and IRC Section 121 does not separately require a period of use as a residence
- Yes, but only half of the $250,000 exclusion is available, prorated for the 18 months of qualifying use out of the required 24-month use period
- No exclusion is available, because IRC Section 121 requires the taxpayer to have used the home as a principal residence for at least 24 months of the 5-year period ending on the sale date, and 18 months of use does not satisfy that test even though the ownership requirement is met
- No exclusion is available, because IRC Section 121 requires the taxpayer to have owned and used the home as a principal residence for the entire 5-year period immediately preceding the sale, with no partial-year allowance
Why C? And why not the others?
Correct answer: C. No exclusion is available, because IRC Section 121 requires the taxpayer to have used the home as a principal residence for at least 24 months of the 5-year period ending on the sale date, and 18 months of use does not satisfy that test even though the ownership requirement is met
IRC Section 121 requires a taxpayer to satisfy both an ownership test and a use test: the home must have been owned for at least 24 months and used as the taxpayer's principal residence for at least 24 months, and both tests must be met at some point during the 5-year period ending on the date of sale, though the qualifying periods need not overlap. Here the taxpayer met the 24-month ownership test but accumulated only 18 months of qualifying use before converting the home to a rental, so the use test fails and no exclusion is available. The option ignoring any use requirement is wrong because Section 121 conditions the exclusion on actual use as a principal residence, not merely on holding title. The option prorating half of the exclusion for partial use is wrong because Section 121's ownership and use tests are pass/fail thresholds, not proportional; falling short of 24 months of use eliminates the exclusion entirely rather than reducing it by half, absent a separate reduced-exclusion exception for specific hardship circumstances that does not apply on these facts. The option requiring ownership and use for the full 5-year period is wrong because the statute only requires 24 months of each within that 5-year window, not continuous occupancy for the entire period.
Source: IRS Topic no. 701, Sale of your home (irs.gov/taxtopics/tc701)