Sale of Residence Exclusion
Richard M. Colombik, JD, CPA
A home is many times the largest asset
that one owns. The rules for excluding the gain from the sale
of a taxpayer's residence were drastically changed in the Taxpayer Relief
Act of 1997. See, P.L. 105-34. The current law allows for
a limited exclusion from recognizing taxation on the gain from the sale
of a principal residence, but does not allow for the recognition or
deduction if a loss is incurred. No loss is allowed as a residence
is considered personal in nature, and losses are only allowed on the
sale of capital assets, not personal assets. IRC §121.
prior law had two provisions for gain exclusions, which have been repealed.
One prior provision allowed for the rollover of a gain and the second
prior rule was allowed for "seniors", over 55 year olds.
current rule allows for a limited exclusion from the sale of a taxpayers
"principal residence". The exclusion is for up to $250,000
for individuals, but also allows for up to $500,000 for married taxpayers
who file a joint income tax return. IRC §121(b); Treas. Regs.
§1.121-2(a). As many code sections, unfortunately the key term,
"principal residence" is NOT defined. Treasury
regulations direct a taxpayer to look at all facts and circumstances
to determine what is a "principal residence". A further
restriction also has a five year review period to determine a "principal
residence". A taxpayer must use the real estate as their
"principal residence" for a period aggregating two or more
years within the five year period ending on the date the home was sold
two of five year period is easier to comply with than many other provisions
of this section. The usage periods, two of five do NOT need to
be continuous. It is an aggregate usage of at least two of the
last five years. See, IRC §121.
exclusion is allowable every time a taxpayer meets their eligibility
requirements, generally it can not be more than once every
two years. Treas. Reg. §1.121-2(b).
In the case of multiple sales a taxpayer may elect to opt out or not
to use the exclusion. IRC §121(f).
What can qualify
as a principal residence?
cases have indicated that a residence may mean different things to different
people. For example, a house trailer, houseboat or even shares
in a cooperative housing corporation qualify as a "principal residence".
Lokan v. Comr., 1979 T.C.M. 380, See also,
PLRs 9637031, 9649017. Even disregarded entity ownership, such
as a grantor or land trust have been recognized to be imputed to the
individual owners for purposes of taking the exclusion. Treas. Reg.
§1.121-1(c)(3). This logic extends to any type of disregarded
entity such as a single member LLC for exclusion as well as ownership.
issue of determining what a principal residence is becomes more complex
if a taxpayer owns more than one home. Treasury regulations provide
a "majority of the time" test to determine principal residence
status. Treas. Reg. §1.121-1(b). The regulations have
a list of factors to review to help in this analysis which include;
address for governmental registration, tax returns, voters card, drivers
within the community, clubs, religious affiliation
a degree of confusion on multiple homes, the IRS allows short term or
temporary absences to be disregarded, but will not issue rulings or
determination letters addressing whether ones property qualifies as
a taxpayers principal residence. Rev. Proc 2004-3, 2004-1 I.R.B.
rules for part of the $250,000 exclusion may also apply if one does
not meet the two of five year rule, but does meet the principal residence
test, if such move is due to a change in place of employment, health,
or other unforeseen circumstances. The change due to employment,
health or other "unforeseen" circumstances, must be the primary
reason for the sale. A sale or exchange is due to unforeseen circumstances
if the primary reason for the sale or exchange is the occurrence of
an event that the taxpayer could not reasonably have anticipated before
purchasing and occupying the residence. If this occurs talk to
your tax advisor about whether you may qualify for the proportionate
remember if you use part of your home for business, the portion attributable
to your business use does NOT qualify for the exclusion rules.
The exclusion is reduced for any depreciation allowed or "allowable"
regarding the business or rental usage of your home. If taxable
a maximum capital gain rate of 25%, versus the 15% rate will apply to
this share of your gain.
joint return, married spouse rule is also a bit tricky. Many rules
must be complied with to obtain the benefit of the $500,000 exclusion
versus the normal $250,000 rule. IRC §121(b)(2) and Treasury Regulation
§1.121-2(a) list the following requisites:
Disqualification - neither spouse is ineligible due to using this provision
during the two-year period ending on the date of the sale or exchange
of the residence
you meet the test, you may be able to exclude up to $500,000 of gain
rules may be a bit tricky, but they can save you a lot of money on the
sale of your "principal residence". A bit of planning
on which property is your residence can go a long way towards keeping
tax dollars in your pocket!