If you file jointly - which is almost always a better filing situation and one that is recommended - then the gain that you are trying to wipe out is indeed $500,000.
@AmyC is absolutely correct that you do not have to show this transaction on your tax return if it is the sale of a primary residence and - after depreciation recapture and everything - the gain is less than 500K.
However, it is always recommended that you include the transaction on your tax return just to avoid having the IRS ask the question later. They have no way to know for sure that the sale was not taxable until you prove it so putting it on your tax return can keep you from getting a letter later.
@campoann526
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