Definition
An IRS provision allowing $250,000 of gain ($500,000 for married couples) from selling a primary residence to be excluded from income tax, if requirements are met (2-of-5 year ownership/use, no prior exclusion in past 2 years).
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The principal residence exclusion is one of the most valuable tax benefits available. If you own and occupy your home as your primary residence for at least 2 of the last 5 years before sale, you can exclude up to $250,000 gain from income tax (married filing jointly: $500,000). This is an enormous benefit—selling a home with a $300,000 gain means no tax if you're married, and only tax on $50,000 if single. The exclusion applies once every 2 years. You cannot claim it if you've claimed it within the past 2 years on another property. The 2-year requirement means you must have occupied the home (not just owned it) as your principal residence for 2 of the 5 years immediately preceding the sale. Renting out your home, moving to a new primary residence, or military deployment can interrupt the occupancy requirement. Understand the rules carefully because missing them by months or failing to track ownership/use properly results in taxable gain you might have excluded. Recent tax law allows exceptions for reduced exclusions if you move due to work, health, or unforeseen circumstances.
Pro Tip
Ensure you meet the 2-of-5 year ownership and occupancy tests before selling. If you moved before 2 years, you might lose the entire exclusion. Document your primary residence status carefully.
Example
A couple buys a home for $300,000, lives in it for 5 years, and sells it for $800,000. Their gain is $500,000. The principal residence exclusion allows them to exclude the entire gain ($500,000), resulting in $0 income tax on the sale.