Principal residence sales by international executives after the TRA '97.

• Author: Stitt, Randall K.
• Position: Taxpayer Relief Act of 1997

By now, everyone knows that the Taxpayer Relief Act of 1997 allowed taxpayers to exclude up to $250,000 of gain ($500,000 if married filing jointly on the sale of a principal residence, if certain requirements are met. what h appens, however, if the seller has been out of the U.S. (i.e., out of the home) on a work assignment? or the seller moves out of the U.S. (i.e., back to his native land) after the sale? These and other thorny questions are analyzed in this article.

Among the changes to the Code in the Taxpayer Relief Act of 1997 (TRA '97) were amendments to the Sec. 121 gain exclusion rules and repeal of the Sec. 1034 gain deferral rules on the sale or exchange of a taxpayer's principal residence. Sec. 121 was amended (and Sec. 1034 was repealed) by TRA '97 Section 312, to provide a single rule permitting gain exclusion only.(1)

The new rule will affect both U.S. expatriates and foreign nationals. As is discussed below, the legislation limits the gain that may be excluded in a qualifying transaction; gain in excess of the limit is subject to tax at the time of the sale or exchange. Further, a taxpayer must own and use the residence as his principal residence for at least two of the five years prior to the sale or exchange to qualify for the full exclusion. A U.S. expatriate taxpayer who rents out his U.S. home during a foreign assignment and reoccupies the home on repatriation for a short period before selling it may not satisfy this requirement.

The TRA '97 also provided that gain attributable to allowable post-May 6, 1997 depreciation of the residence must be recognized on a sale or exchange. As depreciation recapture generally was not recognized under pre-TRA '97 Sec. 1034 or 121, this provision may result in additional tax being attributable when renting out a principal residence during an assignment. Foreign national taxpayers can benefit from the legislation, because U.S. nonresidents are not prohibited from using the new exclusion. In addition, qualifying sales by former U.S. citizens and long-term residents within the five-year lookback period of Sec. 877 should be exempt from taxation under the expatriation rules.

New Law

Generally under TRA '97 Section 312(a), amending Sec. 121, a taxpayer can exclude up to $250,000 of gain realized on the sale or exchange of a principal residence. To be eligible for the exclusion, under Sec. 121 (a), the taxpayer must have owned the residence and used it as a principal residence for at least two of the five years prior to the sale or exchange ("ownership/use tests"). Under Sec. 121(b)(2), married taxpayers filing jointly may exclude up to $500,000 if either spouse meets the ownership test, both spouses meet the use test and neither spouse is ineligible for the exclusion by reason of a prior sale under Sec. 121(b)(3). Sec. 121,(b)(3) states that the exclusion may be applied to one sale every two years (without regard to any sale before May 7, 1997). Further, according to Sec. 121(d)(6), gain must be recognized to the extent of any depreciation allowable for the rental or business use of the residence after May 6, 1997.

Under Sec. 121(c)(2)(b), a taxpayer who does not meet the ownership/use tests may qualify for a prorated exclusion if such failure is due to a change of place of employment, health or unforeseen circumstances. However, for sales before Aug. 5, 1999, the proration rule applies without regard to the requirement of change of place of employment, health or unforeseen circumstances.

According to TRA '97 Section 312(d), the new law applies to all sales or exchanges of a principal residence occurring after May 6, 1997. However, a taxpayer may instead elect to apply prior law to a sale or exchange (1) occurring before Aug. 5, 1997, (2) occurring after Aug. 5, 1997 under a binding contract in effect on that date or (3) of a replacement residence acquired before Aug. 6, 1997 (or under a binding contract in effect on Aug. 5, 1997) in a qualifying rollover transaction. A pending technical correction would provide that a taxpayer could elect to apply pre-TRA '97 law to a sale or exchange on Aug. 5, 1997.(2) Sec. 121(g) provides that if the taxpayer acquired his current residence in a rollover transaction, periods of ownership and use of the prior residence may be taken into account in determining ownership and use of the current residence.

Dollar Limit

As was discussed, up to $250,000 ($500,000 if married filing jointly)...