Final and temp. sec. 121 regs. on gain exclusion.

• Author: Packard, Pamela

As the economy continues on somewhat unsteady ground and the stock market remains uncertain, saving taxes might not be an investor's primary concern. However, this is not the case for homeowners realizing large gains on the sale of their homes, as the real estate market, at the moment, remains recession proof. Thus, many homeowners probably breathed a sigh of relief when the IRS recently issued final, temporary and proposed regulations on excluding gain from the sale of a principal residence.

The Taxpayer Relief Act of 1997 substituted the Sec. 1034 rules with regulations that allow taxpayers to exclude $250,000 ($500,000 for joint returns) on the sale or exchange of a principal residence they owned and lived in for two of the five years before the sale. Taxpayers can generally use the gain exclusion repeatedly, but not more than once every two years. The new regulations also clarify the definition of "personal residence." Further, changes in the new regulations affect how tax-payers can (1) exclude gain from the sale of vacant land used as part of a residence, (2) allocate gain between business and residential uses of a home, (3) apply the rules if unmarried joint owners, (4) fulfill the ownership and use tests and (5) exclude at least part of the gain when they fail to meet those tests.

While the final and temporary regulations apply to sales occurring after Dec. 23, 2002, taxpayers may retroactively apply the rules to any sale occurring after May 7, 1997, by filing an amended return. Thus, a taxpayer who has already reported gain from the sale of a residence and qualifies for a reduced maximum exclusion under the new regulations can file Form 1040X, if the period for filing an amended return has not closed. He or she can also elect not to claim the exclusion within three years of the return's due date for the sale year.

Gain on Sale of Vacant Land

Kegs. Sec. 1.121-1(b)(3) allows only one maximum exclusion for both a residence and vacant land. The vacant land must be adjacent to the dwelling unit of a taxpayer's principal residence, the dwelling unit must be sold or exchanged within two years before or after the sale or exchange date of the vacant land, and the vacant land must have been used by the taxpayer as part of the principal residence. Thus, if the taxpayer sells the land before selling the principal residence adjacent to such land, he or she would have to recognize gain in the sale year. If the taxpayer then sells the principal...