Tax Tip: Plan Ahead When Selling the Principal Residence

Tax Breaks from the Sale of the Principal Residence — They are Not Automatic

Most homeowners know there are various tax savings in many instances when a taxpayer in the US owns a home.  (A “home” in this instance means a broad definition of the term as employed by the US Code (Tax Law).  The home can include not only a single-family structure, but many other settings, such as the personal use of the property for the dwelling of the taxpayer, even if the property is a single-family home, a duplex, a condo, a cooperative, etc.  (The only part that would qualify, of course, for the home use for the tax benefits noted in this Tip is the part that is for personal use, such as ½ of the duplex, the part occupied by the taxpayer.)

In this setting, a taxpayer who itemizes deductions for the Federal tax return of the taxpayer would claim, if applicable, an interest deduction on the interest on the home loan and property taxes paid on the home.  (Once again, this assumes the taxpayer is qualified for the deduction when itemizing deductions on the Federal tax return.)

Another major tax benefit in owing a principal residence is the possibility of meeting the special tax rule under Code Section 121, that is, the Section of the law that allows taxpayers, when selling their principal residence, to exclude part or all the gain, if the taxpayer can qualify for this rule.  Qualification for the married couple, filing a joint tax return, is normally a showing that the married couple occupied the principal residence for at least 2 out of the last 5 years as their principal residence.  If qualified, the taxpayers can normally exclude up to $500,000 of gain on the sale of the home. 

This is not a new rule.  However, a recent case made me think that it is worthwhile mentioning that if one does not follow all the requirements of the special Code Section, the exclusion may be lost.

In the recent case of Pesarik v. Commissioner of the IRS (2/2026), the Chief Judge of the Tax Court denied the taxpayer the right to exclude the gain on the sale of the principal residence.  Why? Because the taxpayer lived in more than one property.  Because the taxpayer could not show the proper 2-year residency requirement as being met, the exclusion was denied.

Further, the taxpayer was denied the right to increase the taxpayer’s basis (cost) by showing that he made capital improvements on the property.  That is, if, for example, a taxpayer made an addition to the home for $50,000, this amount would normally increase the amount the owner had invested in the house and thus reduce the profit on the sale.  However, the taxpayer must prove the monies were spent to improve the property, such as the example noted above.  Pesarik could not show such proof, so the Court would not give the taxpayer full credit for the increased costs.  As such, the taxpayer had to pay more tax on the gain on the sale of the home.  Thus, the taxpayer lost the exclusion and lost the benefit of reducing the gain because of improvements in the home.

The moral of the story is simple: Comply with the law as to prerequisites to claim the exclusion on the sale and maintain proof to show monies were spent on the home to make major improvements.

For more in this area, see Levine, Mark Lee and Segev, Libbi Levine, Real Estate Transactions, Tax Planning (Thomson/Reuters/West 2026), Chapter 28.

By

Prof Mark Lee Levine, University of Denver