Section 121 vs 1031 Exchange

Section 121 is a permanent exclusion of up to $250,000 ($500,000 MFJ) of gain on the sale of a primary residence — the gain disappears forever. Section 1031 is unlimited deferral (not exclusion) of gain on the exchange of investment or business real property — tax is owed eventually, but pushed forward into the basis of the replacement property.

Only your primary residence — the home you have owned AND used as your main home for at least 2 of the last 5 years before sale (the "ownership and use tests"). The two periods don't have to overlap. Vacation homes, rental properties, and second homes do not qualify. Married couples can each separately meet the use test (jointly the ownership test) to claim the full $500,000 MFJ exclusion.

Real property held for investment or use in a trade or business — rental homes, commercial buildings, raw land, leaseholds (30+ years remaining). Personal residences, inventory, and stocks/bonds/partnership interests are excluded. The Form 8824 like-kind requirement is broad for real estate — any real property exchanged for any other real property in the US qualifies (one apartment building for raw land + warehouses is fine).

You must have owned the home for at least 2 of the last 5 years AND used it as your main home for at least 2 of the last 5 years before the sale. The two 2-year periods don't need to be the same 2 years and don't have to be continuous. You can claim full Section 121 once every 2 years. Partial exclusions are available for sale due to a change in employment, health, or unforeseen circumstances.

After selling the relinquished property, you have 45 calendar days to identify potential replacement properties in writing to a qualified intermediary, and 180 calendar days (or your tax-return due date, whichever is earlier) to close on the replacement. Both deadlines are absolute — no weekend/holiday extensions, no IRS waivers. Identification must follow one of three rules: 3-property rule, 200% rule, or 95% rule. See Form 8824 instructions.

Yes — for property that has served as both a primary residence and a rental, you can layer the two strategies. Rev. Proc. 2005-14 allows you to first apply Section 121 ($250k/$500k exclusion on the residence portion), then defer the remaining gain via 1031 on the investment portion. The classic example: rent out a former primary residence for 1–2 years before selling and 1031-ing into a different rental.

Section 121 does NOT exclude depreciation recapture on the home — any depreciation taken (e.g., for a home-office or rental period after May 6, 1997) is taxed at up to 25% as unrecaptured Section 1250 gain. Section 1031 fully defers depreciation recapture into the replacement property's basis. If you eventually sell the 1031 replacement without exchanging again, all the cumulative recapture comes due at once — though if you die holding it, your heirs receive a stepped-up basis that wipes out the deferred gain (subject to estate tax).

They serve different purposes. Section 121 is the only way to permanently eliminate gain on a primary residence — use it whenever you sell. Section 1031 is for investment properties when you want to keep growing real-estate exposure without paying capital-gains tax along the way. Long-term real-estate investors typically chain 1031 exchanges for decades and rely on the step-up at death; short-term homeowners use Section 121 every 2 years.