Sec. 121 exclusion available to bankruptcy estate.

• Author: Hryshko, Dawn
• Position: IRC s. 121

In a recent bankruptcy case, In re Popa, Bktcy Ct. III. (1998), the court held that the recently amended Sec. 121 gain exclusion on the sale of a principal residence was available to the trustee of a bankruptcy estate. Two previous bankruptcy cases had held that the prior-law Sec. 121 gain exclusion was unavailable to a trustee.

An individual debtor, Luciano Popa, had filed a Chapter 7 bankruptcy petition (a liquidation) in August 1996 and received discharge of his debts in December 1996. One of the assets the debtor scheduled was his principal residence, the estimated fair market value of which was $150,000. However, after deducting the outstanding mortgage, estimated broker's cost and dosing fees on a sale, trustee's fees and the homestead exemption, the debtor estimated that there would be only about $8,600 of equity available to be distributed to unsecured creditors. In addition, the court determined the income tax due from the estate on the sale of the home would be approximately $12,000, if the Sec. 121 exclusion was not available to the trustee. This was the result sought by the debtor; because there would be no equity in the home, the bankruptcy trustee would be forced to release it to the debtor. In addition, the IRS was also seeking this result, so that the maximum tax could be collected on the sale of the residence by the bankruptcy estate. On the other hand, the bankruptcy trustee sought to use the Sec. 121 exclusion to maximize the funds for the benefit of the unsecured creditors.

The court found no cases addressing whether a bankruptcy estate succeeds to the debtor's eligibility for the Sec. 121 exclusion as amended by the Taxpayer Relief Act of 1997. Two cases under prior law held that the bankruptcy trustee could not use the onetime exclusion for individuals over age 55: In re Mehr (Bktcy Ct. N.J. (1993)) and In re Barden (DC N.Y. (1996)). The court declined to follow these decisions, pointing out that they were based on original Sec. 121, which provided for an elective one-time exclusion from income, while current Sec. 121 permits a nonelective exclusion anytime a taxpayer qualifies. More significant than these changes, however, the court felt that the prior decisions did not give proper weight to the relevant Code provisions controlling the taxation of bankruptcy estates. The court pointed out that Mehr and Barden did not discuss Sec. 1398(f)(1) in any meaningful way and their analysis of Sec...