The short answer
Rev. Proc. 2005-14 is the IRS revenue procedure that explains how to apply the section 121 home sale exclusion and section 1031 deferral to a single exchange of property that qualifies under both. Section 121 applies first; section 1031 can then defer the remaining gain, including gain from depreciation that section 121 cannot exclude. Cash you receive is taxed only to the extent it exceeds the excluded gain, and the excluded gain is added to your replacement basis.
At a glance
| Order | Apply section 121 first, then section 1031 |
|---|---|
| Exclusion cap | $250,000, or $500,000 for certain joint returns |
| Depreciation gain | Not excludable under section 121 but can be deferred under section 1031 |
| Five-year rule | No section 121 exclusion on a sale within five years of acquiring the home in a 1031 exchange |
Three ordering rules do all the work.
Section 4.02 of Rev. Proc. 2005-14 says section 121 is applied to the realized gain before section 1031. Gain from depreciation after May 6, 1997, which section 121(d)(6) keeps out of the exclusion, may still be deferred under section 1031. Boot is taken into account only to the extent it exceeds the gain excluded under section 121.
Section 4.03 sets basis: the excluded gain is treated as gain recognized, so it increases the basis of the replacement business property. The procedure applies only where the relinquished and replacement property meet the held-for-use-or-investment test, so the home must already be a rental or business property at the time of the exchange.
The procedure is effective January 27, 2005, and section 6 lets taxpayers apply it to earlier years still open for refund claims under section 6511.
Example 1 in the revenue procedure shows the result with real numbers.
An unmarried owner buys a house for $210,000 and lives in it from 2000 to 2004, then rents it from 2004 to 2006, claiming $20,000 of depreciation. In 2006 the owner exchanges it for a $460,000 rental townhouse plus $10,000 cash. Realized gain is $280,000, on an amount realized of $470,000 and an adjusted basis of $190,000.
Section 121 excludes $250,000. The remaining $30,000, including the $20,000 from depreciation, is deferred under section 1031. The $10,000 cash is not taxed because it does not exceed the excluded gain. Basis in the townhouse is $190,000 plus $250,000 excluded, minus $10,000 cash, or $430,000. Your own dates and figures will differ, so run them with your CPA.
Example 5 shows the cap working across portions. With $220,000 of gain on the residence portion, only $30,000 of the office gain can be excluded before the $250,000 limit is reached, and the remaining $110,000 of office gain is deferred under section 1031.
Examples 2 to 6 cover a house with a separate guesthouse office, an office inside the home, and gain above the $250,000 cap, which is recognized.
It bites on timing, on recapture and on the next sale.
Section 121 needs ownership and use as a principal residence for two of the five years before the sale, so a home rented too long loses the exclusion; the comparison is laid out in section 121 versus 1031 for a former home.
The reverse path has its own trap. Under section 121(d)(10), if you acquired the home in a section 1031 exchange, no exclusion applies to a sale within five years of that acquisition; see moving into a replacement property and primary residence or second home.
Related questions
Does the deferred depreciation disappear?
No. It is deferred under section 1031 and carried into the replacement property's basis, so it can be recaptured when that property is later sold in a taxable sale.
Does the revenue procedure apply to a home I still live in?
Only the business or investment portion can be exchanged. Examples 2 and 3 split a property between a residence and an office and apply section 1031 only to the office portion.
Is the $500,000 joint exclusion available?
Section 121(b) allows $500,000 for certain joint returns. The revenue procedure's examples use an unmarried owner and the $250,000 limit.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.