Section 121 Exclusion Rules After the Death of a Spouse

When a spouse dies, the surviving spouse can still claim the full $500,000 home sale exclusion that was available to the couple, but only if the sale closes within two years of the date of death and the survivor has not remarried by the closing date. That is the core of the Section 121 exclusion after the death of a spouse. Combined with a stepped-up cost basis that erases pre-death appreciation, the two-year rule often wipes out the federal tax on the sale entirely. Miss the window, and the exclusion drops to the $250,000 single-filer amount.

The Two-Year Window

A single filer normally excludes only $250,000 of gain on the sale of a principal residence. A surviving spouse keeps access to the $500,000 joint amount if the sale closes no later than two years after the date of death.¹ Three conditions have to line up:

The sale closes within two years of the date of death.
The surviving spouse has not remarried before the sale date.
The couple met the ownership and use requirements immediately before the date of death.

The surviving spouse also cannot have used the Section 121 exclusion on a different home sale within the two years before this one.¹ The clock runs from the actual date of death to the closing date, not the listing date. If closing slips even one day past the two-year mark, the exclusion falls to $250,000.

Ownership and Use Tests

To claim any Section 121 exclusion, the taxpayer must have owned and used the home as a principal residence for at least two of the five years ending on the sale date. The two years of ownership and two years of use do not have to be consecutive or overlap.¹

A tacking rule makes this much easier for a surviving spouse. You can count the deceased spouse’s periods of ownership and use as your own.¹ If your spouse owned and lived in the home for fifteen years but you were added to title only a year before the death, you still satisfy both tests. Tacking applies regardless of how title was held.

There is a separate wrinkle for the $500,000 amount. The joint-return requirements have to be met “immediately before” the date of death, which means both spouses used the home as their principal residence for two of the five years ending on that date. If one spouse moved to a nursing home four years before death and never returned, that use test may not be satisfied as of the date of death, and the $500,000 amount can be lost even though the survivor still qualifies for $250,000.

How the Stepped-Up Basis Cuts the Gain

Gain on a home sale is the sale price minus the property’s adjusted cost basis. When a spouse dies, the basis is adjusted to the home’s fair market value on the date of death, wiping out appreciation that built up during the marriage.² How much of the property gets that step-up depends on how title was held and which state you live in.

Sole Ownership by the Deceased Spouse

When the deceased spouse was the sole owner and the surviving spouse inherits the entire property, the full basis steps up to fair market value at the date of death. A home bought for $150,000 and worth $500,000 at death gets a new basis of $500,000. The only gain later taxed is appreciation between the date of death and the sale.

Joint Ownership in Common Law States

Most states are common law property states. When spouses jointly own a home in a common law state, only the deceased spouse’s half of the property steps up. The surviving spouse’s half keeps its original basis.²

Say a couple paid $200,000 for a home worth $600,000 at death. The deceased spouse’s half steps up from $100,000 to $300,000. The surviving spouse’s half stays at $100,000. Combined new basis is $400,000. A sale at $600,000 produces $200,000 of gain, well within the $500,000 exclusion.

Community Property States

In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), both halves of a marital home receive a full step-up to fair market value at the date of death.² Using the same numbers, the entire basis jumps from $200,000 to $600,000. A sale at $600,000 produces zero gain. The difference between a common law and community property state on the same facts can be hundreds of thousands of dollars in erased gain.

The Alternate Valuation Date

If an estate tax return is required, the executor can elect to value estate assets as of six months after the date of death rather than the date of death itself. The election is only available if it decreases both the gross estate and the estate tax owed.³ When the executor makes that election, the stepped-up basis for income tax purposes also shifts to the alternate date. If home values fell during those six months, the election lowers the basis and increases the survivor’s taxable gain on a later sale. The estate tax benefit and the income tax consequence can point in opposite directions, so coordinate with whoever is handling the estate before the election is made.

If You Remarry Before Selling

Remarrying before the sale closes eliminates the special $500,000 surviving spouse exclusion. The statute is explicit: the seller must be unmarried on the date of sale to use that provision.¹ That does not automatically drop the exclusion to $250,000. If the survivor and the new spouse file jointly, the couple can claim up to $500,000 under the ordinary joint-return rules, as long as both spouses meet the use test, at least one meets the ownership test, and neither used the exclusion on a different sale in the prior two years.⁴

The practical problem is that the new spouse has almost certainly not lived in the home for two of the past five years. If only the surviving spouse meets the use test, the couple’s joint-return exclusion is capped at $250,000. Timing matters: a surviving spouse who plans to both remarry and sell often benefits from closing the sale first.

Renting or Leaving the Home Vacant

A surviving spouse does not always sell right away. The home might sit empty during probate, or the survivor might rent it out to cover carrying costs. Both situations raise the question of whether that non-residence period cuts into the exclusion.

Any period after the last date the home was used as a principal residence by the taxpayer or their spouse is not treated as nonqualified use.¹ Living in the home until your spouse died and then leaving it vacant or renting it before sale does not trigger the nonqualified use allocation that would shrink the excludable gain.

The trap sits earlier in the timeline. If the home had a period of nonqualified use before it became your principal residence — say the couple bought it as a rental, then moved in later — that earlier period does reduce the portion of gain eligible for exclusion. Gain is allocated proportionally, using the ratio of nonqualified use to total ownership.¹

Renting after the death creates a separate depreciation issue. The rental period does not count as nonqualified use for exclusion purposes, but you still have to depreciate the property while it is rented. Depreciation claimed after May 6, 1997 cannot be excluded under Section 121 even when the rest of the gain qualifies, and the recaptured depreciation is taxed at a rate of up to 25%.

Homes Held in a Revocable Trust

Many couples hold their home in a revocable living trust. The IRS treats a grantor trust as if the grantor personally owns the property, so as long as the surviving spouse is treated as owner under the grantor trust rules, a sale by the trust is treated as a sale by the surviving spouse for Section 121 purposes.⁵ The ownership, use, and exclusion rules apply normally.

The picture changes if the trust becomes irrevocable after the spouse’s death and the survivor is no longer treated as its owner for tax purposes. An irrevocable trust filing its own return generally cannot claim Section 121, because the trust itself does not “use” the home as a principal residence. The same is true if the home is sold by the deceased spouse’s estate rather than by the surviving spouse individually. Congress briefly allowed estates and certain trusts to use the exclusion, but that provision was repealed for decedents dying after 2009.¹ Getting title transferred to the surviving spouse personally, or keeping the trust as a grantor trust, before the sale is critical to preserving the exclusion.

Partial Exclusion When the Tests Aren’t Met

Sometimes a surviving spouse cannot meet the two-year ownership or use test, even with tacking. The couple may have bought the home recently, or the sale has to happen quickly. In those situations, the death of a spouse qualifies as a safe harbor “unforeseen circumstance” under IRS regulations, and the surviving spouse gets a reduced exclusion rather than none.⁴

The partial exclusion uses the shortest of three periods: how long you lived in the home during the five-year lookback, how long you owned it, or the time since you last used the Section 121 exclusion. Divide that period by two years (730 days or 24 months), then multiply by $250,000, or by $500,000 if you otherwise qualify for the surviving spouse amount.⁴ Eighteen months of ownership and use, for instance, produces a partial exclusion of 18/24 × $250,000 = $187,500.

Reporting the Sale and Documenting Basis

If gain exceeds the exclusion, the taxable portion is reported on Form 8949, which feeds into Schedule D attached to Form 1040.⁶ Inherited property is always treated as held long-term, so the gain qualifies for long-term capital gains rates regardless of how quickly you sell. High-income sellers may also owe the 3.8% net investment income tax on the taxable portion.

One reporting nuance catches people off guard. If you receive a Form 1099-S from the title company or closing agent, you must report the sale on your return even if the gain is fully excluded.⁶ You will not owe tax, but you have to file Form 8949 to show the IRS that the exclusion covers the gain. Skipping this step can trigger an automated notice that assumes tax is owed on the full sale price.

The stepped-up basis is only as defensible as the documentation behind it. The strongest evidence is a professional appraisal by a licensed appraiser stating fair market value as of the date of death (or the alternate valuation date if elected). Residential appraisals typically run $300 to $600, higher for complex or high-value properties. The value reported on Form 706, if an estate tax return was filed, also works, as does a comparative market analysis prepared near the date of death. Property tax assessments alone are not reliable, because assessed values often lag market values. Keep the appraisal, the death certificate, and records of any post-death improvements. If the IRS challenges the basis, the burden falls on the taxpayer, and a professional appraisal dated close to the death is the cleanest way to meet it.

1
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
2
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
3
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
4
Internal Revenue Service. Publication 523, Selling Your Home
5
eCFR. 26 CFR 1.121-1 – Exclusion of Gain From Sale or Exchange of a Principal Residence
6
Internal Revenue Service. Topic No. 701, Sale of Your Home