They Put the House in a Living Trust in 2015 and Will Sell It Next Spring. The IRS Will Still Give Them the Married Couple’s $500,000, Because a Revocable Trust Is Invisible to the Tax Code

Many married couples moved their home into a revocable living trust years ago to help their heirs avoid probate. Many now assume the move cost them the home sale tax break, but the break remains available. A couple who retitled their home in 2015 and sells it next spring can still exclude up to $500,000 of gain under the Section 121 home sale exclusion. The deed may name the trust as owner, but federal income tax law looks straight through the trust to the couple who control it.

How a Living Trust Vanishes at Tax Time

A revocable living trust is a grantor trust. The people who create it, called grantors, can cancel it and take the property back whenever they want, so the tax code treats them as the owners of everything inside the trust. If the trust sells the house, the IRS treats the sale as if the couple sold it themselves, and years of ownership under the trust count as the couple’s own ownership, with the couple claiming the joint exclusion on their own return.

Two Code Sections Behind the Trust Treatment

The first anchor is 26 U.S.C. § 676(a). It says the grantor “shall be treated as the owner of any portion of a trust” where the power to take back title is exercisable by the grantor. The second is the Treasury regulation that applies Section 121 to trusts. The grantor may be treated as the trust’s owner. Under 26 CFR 1.121-1(c)(3)(i), when that happens, “the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.”

The dollar cap comes from the law. Section 121(b)(1) sets a $250,000 limit, and Section 121(b)(2)(A) swaps in $500,000 for qualifying joint returns.

Which Couples Qualify for the Full $500,000

Under 26 U.S.C. § 121(b)(2)(A), the larger exclusion applies when a married couple files jointly for the year of the sale and meets three conditions:

• Either spouse meets the ownership test, meaning the home was owned for at least 2 years during the 5-year period ending on the sale date. Trust ownership counts.
• Both spouses meet the use test, meaning each lived there as a principal residence for periods adding up to 2 years in that same window.
• Neither spouse took the exclusion on another home sale during the 2-year period before this one, per Section 121(b)(3).

Couples who file separately fall back to the $250,000 individual limit. Trusts that fall outside the grantor trust rules, including many irrevocable trusts, lose the look-through treatment, and Section 121(e) also bars the exclusion for certain expats covered by Section 877(a)(1).

Steps to Claim the Break on a Spring Sale

1. Pull out the trust document and confirm who is treated as the owner of the trust’s residence for federal income-tax purposes. Both spouses do not have to be grantors for the couple to qualify.
2. Count each spouse’s time living in the home within the five years ending on the closing date. The periods do not need to be continuous, since the law requires “periods aggregating 2 years or more.”
3. Figure the gain: the sale price minus selling costs, minus the couple’s adjusted basis (original purchase price plus capital improvements). Retitling the home to a grantor trust in 2015 left that basis unchanged, because the IRS still views the couple as owners.
4. File a joint return for the year of the sale. Up to $500,000 of gain is excluded. Any gain above that amount is taxed as a capital gain.

Where the Trust Treatment Breaks Down

The regulation protects the sale only “for the period that a taxpayer is treated under sections 671 through 679” as the trust’s owner. That status depends on the power to cancel. Many joint trusts split when the first spouse dies, moving the deceased spouse’s share into an irrevocable subtrust. The surviving spouse may no longer be treated as owning that share, which can put part of the sale outside the trust rule.

A second deadline applies after a death. Under Section 121(b)(4), an unmarried surviving spouse may retain the $500,000 limit if the sale occurs within two years after the spouse’s death and the joint-exclusion requirements were met immediately before death. After that window closes, the cap drops to $250,000.

The law also fixes the figure. Section 121 sets the $500,000 amount with no inflation adjustment, so it applies unchanged to sales in 2026. Members of recent Congresses have introduced multiple bills that would change the exclusion, but the current law still caps joint gain at $500,000. In high-appreciation markets, that means a home bought decades ago can produce taxable gain even after the full exclusion. Any legislation enacted before the sale would need to be checked for its effective date.

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