If a homeowner becomes unable to care for themselves and lived in the home at least 1 year of the 5 years before the sale, time spent in a state-licensed care facility such as a nursing home counts toward the 2-year residence test for the $250,000 or $500,000 home sale exclusion (26 U.S.C. 121(d)(7); IRS Publication 523 (2025), checked October 14, 2026).
Three paths for the house
Most families end up on one of three paths: keep the house, sell it, or borrow against it. The answer depends on whether a spouse still lives there, how large the gain is, how long care may last, and your state's Medicaid rules. Start with how much long-term care costs in your area.
Keeping the house
For Medicaid, the home is generally an excluded asset (42 U.S.C. 1382b(a)(1), checked October 14, 2026). Under the federal SSI rule many states follow, the home stays excluded while the owner is in a facility if a spouse or dependent relative lives there; otherwise the owner's intent to return matters (20 CFR 416.1212(c)). For nursing home Medicaid, the state also applies a home equity limit, between $752,000 and $1,130,000 in 2026, unless a spouse or certain children live there (CMS, Informational Bulletin: Updated 2026 SSI and Spousal Impoverishment Standards, April 27, 2026). States differ, so confirm with your state Medicaid office.
Keeping it has two big consequences. After death, the state may seek repayment from the estate under Medicaid estate recovery. And heirs who inherit it generally take a basis equal to its value at death (26 U.S.C. 1014, checked October 14, 2026), which can erase decades of gain for income tax. Try the step-up in basis calculator.
Selling: the home sale exclusion and the nursing home rule
A seller can exclude up to $250,000 of gain, or $500,000 for a married couple filing jointly, if they owned and lived in the home as their main home for at least 2 of the 5 years before the sale (26 U.S.C. 121, checked October 14, 2026; IRS Topic No. 701).
The nursing home rule helps. If the owner becomes physically or mentally unable to care for themselves, and lived in the home at least 1 year of the 5 years, time in a state-licensed facility such as a nursing home counts as living in the home (26 U.S.C. 121(d)(7); IRS Publication 523 (2025)). A widow or widower who sells within 2 years of the spouse's death can still exclude up to $500,000 if the joint requirements were met just before the death (26 U.S.C. 121(b)(4)).
Gain above the exclusion is taxed. For 2026, long-term gain is taxed at 0% up to $49,450 of taxable income for a single filer ($98,900 joint), 15% up to $545,500 ($613,700 joint), and 20% above that (IRS, Rev. Proc. 2025-32, October 2025). The 3.8% net investment income tax can also apply when modified adjusted gross income is over $200,000 single or $250,000 joint (26 U.S.C. 1411). State income tax varies. See selling a home with a large gain.
How sale proceeds affect Medicaid
A sale turns an excluded asset into countable cash. Once the house is sold, the proceeds generally must be used before Medicaid will pay; see Medicaid spend-down. Selling below market value, for example to a relative, is a transfer that can trigger a penalty under the look-back period. For a married couple, the spousal rules decide how much the spouse at home keeps; ask your state how a sale before or after the application is treated.
An installment sale, and a reverse mortgage
Installment sale. In an installment sale, the buyer pays over time and the seller reports gain as payments arrive, instead of all in the year of sale (26 U.S.C. 453; IRS Form 6252). For a main home, the excluded gain comes off first; only gain above the exclusion is spread (IRS Form 6252, line 15). Spreading can keep more gain in a lower bracket or under the 3.8% tax threshold. The trade-offs, once: the buyer may not pay, so the note needs real security; the money arrives over years, while care bills arrive monthly; for Medicaid, a note may be treated as a transfer unless it is actuarially sound, pays in equal amounts with no balloon, and cannot be canceled at the seller's death (42 U.S.C. 1396p(c)(1)(I)), and even a note that passes may count as income or a resource in your state; and it must be set up before closing, not after. See Form 6252 and installment sales.
Reverse mortgage. Federal Medicaid law allows a reverse mortgage or home equity loan to reduce home equity (42 U.S.C. 1396p(f)(3)). But a federally insured reverse mortgage becomes due if no borrower lives in the home for more than 12 consecutive months because of illness, unless another borrower still lives there (24 CFR 206.27(c)(2)(ii), checked October 14, 2026). It tends to fit when one spouse will stay home. See how a reverse mortgage works.
A decision table, and when each path can make sense
| Situation | Path that often fits | Main catch |
|---|---|---|
| A spouse or disabled child lives in the home | Keep | Recovery waits, but may come later |
| Single owner, short expected stay, plan to return | Keep for now | Upkeep, taxes and insurance on an empty house |
| Single owner, long stay, gain under the exclusion | Sell | Proceeds are spent before Medicaid pays |
| Large gain above the exclusion, heirs want the house | Keep for the step-up | Estate recovery and equity limit |
| Large gain above the exclusion, must sell | Sell, possibly as an installment sale | Buyer risk, timing, Medicaid note rules |
| One spouse stays home and needs cash | Reverse mortgage | Loan costs; due if no borrower lives there |
Each path has a fair use. Before deciding, a tax professional can run the sale numbers and an elder law attorney can check your state's Medicaid rules. Free help is available through the Eldercare Locator (1-800-677-1116).
A plain example: a widow's $900,000 house
Hypothetical: a widow, 82, has lived in a nursing home for 3 years. She bought her house for $180,000 and added $40,000 of improvements, so her basis is $220,000. It sells for $900,000 with 6% selling costs. Because she can no longer care for herself and lived there more than a year of the last five, her nursing home time counts and she keeps the $250,000 exclusion. We assume her other taxable income after deductions is $60,000 and her other modified adjusted gross income is $75,000, so all of the taxable gain falls in the 15% bracket. Federal tax only.
| Item | Sell for cash | Installment sale: 20% down, 4 yearly payments |
|---|---|---|
| Sale price less 6% selling costs | $846,000 | $846,000 |
| Gain ($846,000 minus $220,000 basis) | $626,000 | $626,000 |
| Excluded under section 121 | $250,000 | $250,000 |
| Taxable gain | $376,000 in year 1 | $75,200 a year for 5 years |
| Federal tax at 15% | $56,400 | $11,280 a year, $56,400 total |
| 3.8% net investment income tax | $9,538 | $0 if income stays under $200,000 |
| Total federal tax | $65,938 | $56,400 |
Arithmetic: $900,000 minus $54,000 = $846,000; minus $220,000 = $626,000; minus $250,000 = $376,000; 15% = $56,400. Her income for the 3.8% tax is $75,000 + $376,000 = $451,000, which is $251,000 over $200,000; that is less than her $376,000 gain, so 3.8% x $251,000 = $9,538. In the installment sale, $376,000 / $900,000 = 41.78% of each $180,000 payment is gain, or $75,200, and $75,000 + $75,200 = $150,200 stays under $200,000, before the interest on the note, which is taxed as ordinary income. After tax, the cash sale leaves $780,062, about 72 months of a private nursing home room at the national median of $10,798 a month (CareScout Cost of Care Survey 2025, data tables dated March 2, 2026). The installment sale saves $9,538 here, but brings the buyer risk and Medicaid note rules above.
Red flags
- A buyer or investor pushing a fast cash sale "before Medicaid takes it" at well below market value.
- Advice to sell the house to a child for a token price. That is a transfer under the look-back rule.
- Being told the over-55 exemption still applies. It was replaced by the current exclusion.
- Someone suggesting you can skip the nursing home rule paperwork. Keep records of residence and the facility's license.
- A plan to carry back a note from a relative with no payments, a balloon, or forgiveness at death.
- Pressure to put sale proceeds into an annuity or insurance product right after closing.
- Being told to sell without first asking whether a spouse or disabled child living there changes the answer.
- Treating the installment sale as tax-free. Gain and interest are still taxed, just over time.
- A reverse mortgage pitch for a home where no borrower will live for more than a year.
- Signing a listing or sale contract before a tax professional has looked at the basis and the exclusion.
Questions to ask before you sign
- What is our basis in the house, including improvements, and what records do we have?
- Does the nursing home time count toward the 2-year test under the section 121(d)(7) rule?
- If one spouse has died, are we within the 2-year window for the $500,000 exclusion?
- How much gain is above the exclusion, and what federal and state tax will it cause?
- Does my state Medicaid program exclude the home while I am in care, and what is its equity limit?
- How would estate recovery apply if we keep the house?
- What would heirs save with a step-up if the house is kept until death?
- If we use an installment sale, how will the note be secured, and does it meet the Medicaid note rules?
- How will my state count the sale proceeds or note payments for Medicaid?
- Would a reverse mortgage work if one of us stays in the home?
Long-Term Care and Your Home: Read This Before You Sign
A one-page checklist: what Medicare will and will not pay, the Medicaid look-back and estate recovery basics, the questions to ask before you buy long-term care coverage or take a reverse mortgage, and the tax rules if the house is sold. The home sale rules on one page: the exclusion, the nursing home rule, installment sales and Medicaid questions. We’ll email it to you.
The Retirement Literacy Foundation is a 501(c)(3) public charity (EIN 41-5062266). General education, not tax, legal or investment advice. Nothing is sold here. Unsubscribe any time.
Sources
- Cornell Law School LII: 26 U.S. Code 121, Exclusion of gain from sale of principal residence (checked October 14, 2026)
- IRS: Publication 523 (2025), Selling Your Home (checked October 14, 2026)
- IRS: Topic No. 701, Sale of your home (checked October 14, 2026)
- IRS: Revenue Procedure 2025-32, 2026 inflation adjustments (October 2025)
- IRS: Form 6252, Installment Sale Income (2025)
- Cornell Law School LII: 26 U.S. Code 1411, Net investment income tax (checked October 14, 2026)
- Cornell Law School LII: 42 U.S. Code 1396p, Liens, adjustments and recoveries, and transfers of assets (checked October 14, 2026)
- CMS: Informational Bulletin, Updated 2026 SSI and Spousal Impoverishment Standards (April 27, 2026)
- eCFR: 24 CFR 206.27, Mortgage provisions (checked October 14, 2026)
- CareScout: Cost of Care Survey 2025 (data tables dated March 2, 2026)
- Cornell Law School LII: 26 U.S. Code 1014, Basis of property acquired from a decedent (checked October 14, 2026)
The Retirement Literacy Foundation is a 501(c)(3) public charity. This page is general education, not tax, legal or investment advice. Nothing is sold here, no product is recommended, and RLF accepts no funding from financial companies. Rules and figures change; each one above shows its source and date. Check anything you plan to act on with your state insurance department or a qualified professional who is not paid on the product.