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The equity you build up in your home may represent the bulk of your wealth when you retire. Should you decide to sell your home to provide capital for retirement or to purchase a retirement home, for instance, current tax law allows homeowners to take a once-in-a-lifetime tax break on capital gains accumulated over the years.

"This exclusion is an effective way to eliminate the capital gains that are built up and deferred from purchase to purchase during a lifetime of being a homeowner," says Cheryl Cloutier, an academic assistant at the College for Financial Planning, a division of the National Endowment for Financial Education.It can be especially critical for those who may be moving into a residence that's less expensive than their current home or who have accrued capital gains over the years.

Under the law, a homeowner may exclude from taxable income up to $125,000 of the total capital gains made on the sale of his or her home. The following simple steps can help you determine whether you are eligible:

First, have you already used the exclusion? If not, the first hurdle is cleared. Everyone is entitled to this exclusion once in his or her life.

Second, has your spouse ever used the exclusion? If not, you are still eligible. This tax law views married couples as one person. "But matters concerning married couples can get more complicated than that," says Cloutier. One such example is called the "tainted spouse." This rule says that if you have never taken the exclusion, but your spouse did before the marriage, then you become ineligible.

Likewise, if a husband and wife use the exclusion, then divorce and remarry other people, neither of the two new couples would be eligible even if the new spouses had never taken the exclusion. If that's the case, the "untainted" spouse is better off taking the exclusion and reaping whatever tax benefits possible before saying "I do."

Third, are you or your spouse over age 55? Under the law, the homeowner or one spouse of a married couple needs to be over age 55 to take the exclusion.

Finally, have you owned the house for three of the past five years, and has it been a principal residence for three of those five years? The latter part of this requirement can affect eligibility in other ways, especially if you own more than one residence, such as a vacation home where you spend several months each year. "To maintain your eligibility for this exclusion, the general advice is that if you're moving to your second home for an extended but temporary period, don't change your permanent address, your driver's license, or anything else that might indicate you've made a change of residence," Cloutier says.

With all of the above requirements passed, a homeowner is probably eligible to take the exclusion and save up to $35,000 in taxes (28 percent of the capital gains of $125,000).

To determine the amount that would be sheltered from taxation, subtract the home's basis - its original purchase price plus the cost of any improvements - from the sale price of the house (minus any selling expenses). For example, if a house with a $45,000 basis is sold for $170,000, the total capital gain is $125,000. This amount would be exempt from taxes under the exclusion.

But the homeowner also needs to determine whether taking this exclusion is the best decision. "Before taking the exclusion, homeowners should really ask themselves why they are selling their residence," says Cloutier. "If they are positive this is the last house they will ever own, it may be a good idea. However, a lot of people feel obligated to take the exclusion because they think they have to get rid of all their capital gains, and that's not the best reason to sell a home."

If a homeowner doesn't take the exclusion, capital gains resulting from the sale of one home and the purchase of another are calculated as with any other sale. Even if the homeowner sells the first home and purchases a less expensive residence, he or she will still be responsible for paying taxes on a portion of the capital gain. In this scenario, the capital gains are calculated using the original value, or basis, of the first home and its final selling price, as well as the basis and purchase price of the new home.

"Of course, if the homeowner has built up a lot of capital losses, forgoing the exclusion and buying a new home where capital gains may be realized is one way to make up for previous losses," according to Cloutier.

Another option for homeowners, especially those who don't plan to own another residence, is to will the home to their heirs. Any capital gains built up during the original homeowners' lifetime will be erased and those who inherit the home will pay taxes based only on the home's fair market value.

"Taking advantage of a once-in-a-lifetime opportunity is not something to be done lightly," says Cloutier. "Before homeowners take this exclusion, they should first examine its potential benefits and consequences and perhaps discuss their options with their financial planner, an accountant or a qualified tax lawyer."

The National Endowment for Financial Education is an independent, nonprofit institution that advocates standards for all financial advisers and is dedicated to a goal of helping Americans achieve financial well-being.