Personal residence gain exclusion: unforeseen circumstances safe harbors.

• Author: Hildabridle, Nick H.F.

Under Sec. 121(a) and (b), taxpayers can exclude up to $250,000 of the gain on the sale or exchange of their principal residence ($500,000 for certain joint returns). However, they must have owned and used the property as a principal residence for at least two of the previous five years ending on the sale or exchange date. Also, under Sec. 121(b)(3), taxpayers can use this exclusion only if they have not used it in the last two years.

Background

On Aug. 13, 2004, the IRS issued final regulations on (1) the gain exclusions and (2) Sec. 121(c)'s special rules for taxpayers who do not meet the two-out-of-five-year test or the two-year limit. Under the latter provision, taxpayers may still qualify for a reduced maximum exclusion if the sale or exchange was due to a change in place of employment, health or unforeseen circumstances; the regulations provide safe harbors to qualify. If a safe harbor is not met, taxpayers might still be able to qualify if they can establish that the sale was "primarily related" to the aforementioned reasons, under Regs. Sec. 1.121-3(b).

Safe Harbors

Employment: According to Regs. Sec. 1.121-3(c)(1) and (2), a sale or exchange is by reason of a change in place of employment if it occurs when the taxpayer owns and uses the property as a principal residence, and the qualified individual's new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment. If there was no former place of employment, the distance between the qualified individual's new place of employment and the residence sold or exchanged must be at least 50 miles. Regs. Sec. 1.121-3(c)(3) defines "employment" as commencement with a new employer, continuation with the same employer or, for self-employed taxpayers, commencement or continuation of self-employment. Regs. Sec. 1.121-3(f) provides that a qualified individual is a:

1. Taxpayer;

2. Taxpayer's spouse;

3. Co-owner of the residence;

4. Person whose principal place of abode is in the same household as the taxpayer; or

5. Person bearing a relationship specified in Sec. 152(a)(1)-(8) (without regard to qualification as a dependent) to a person described in items 1-4 above, or a descendant of the taxpayer's grandparent.

   Example 1: A is employed by T at T's South Bend, IN office. She purchased a house in June 2002 that is 35 miles from there. In May 2003, A began a temporary assignment at T's Oakbrook, IL office, which is 75 miles from her...