Stuart Levine has an interesting illustration of the § 121 exclusion of gains on the sale of a home, courtesy of the sentencing memorandum submitted by the prosecution in the Randy "Duke" Cunningham (R-CA) case [blogged here]:

First, he sold his residence to a "briber" for $1.5 million. After he discovered that he would not have sufficient cash to purchase a "monster" mansion that he wanted, he re-papered the sale of the home to reflect a sale price of $1.675 million. The home was only worth $975,000. Subsequently, after he was informed by his accountant that the profit on the sale, because it was in excess of $500,000, would generate tax at capital gains rates, he hit up the "briber" for another $115,100 to pay the tax. This payment was disguised as a "public relations and communications expense" and was payable to Cunningham’s military memorabilia business. Of course, Cunningham got the tax results all wrong. The spread between $975,000 and $1.675 million was a bribe, as was the payment of the $115,100. Thus, Cunningham had ordinary income, subject to SECA, of $815,500. He had capital gain on the sale of the home on the difference between his basis and $975,000, although he would only have to recognize the gain to the extent that it exceeded $500,000.