Sec. 121 planning opportunities after the Housing Assistance Tax Act.

• Author: Cockrum, Robert B.

The Housing Assistance Tax Act of 008 (the Housing Act) implemented major revisions to Sec. 121. (1) The Housing Act provided many tax incentives for the housing market, (2) and it was necessary to counterbalance the $15 billion of tax incentives with a like amount of new tax revenues, which the Sec. 121 revisions are designed to help provide.

The changes to Sec. 121 do not affect the core mechanisms of Sec. 121, but several of the tax planning opportunities that have developed since the 1997 overhaul of Sec. 121 will be eliminated or gradually eliminated. This article discusses the new law changes and how and when those changes affect prior and future planning.

Overview of Sec. 121

Under Sec. 121, taxpayers who sell a principal residence can exclude the capital gain on the sale in certain circumstances. Sec. 121 allows an unlimited number of successive sales of principal personal residences and gives the seller a limited capital gain exclusion per sale (up to $250,000/$500,000 depending on filing status). (3) The section requires ownership/ use of the principal residence for two of five years immediately prior to the sale, (4) and only one principal personal residence sale every two years is allowed. (5)

Not only were multiple sales of principal residences allowed under Sec. 121 as it was revised in 1997, but periods of ownership were counted when the property was not in fact used as the taxpayer's principal personal residence. This allowed significant tax planning opportunities for vacation homes and investment properties. Both the vacation home and investment property planning opportunities are limited by the Housing Act Sec. 121 revisions.

The Housing Act also extended the periods for compliance with Sec. 121 up to 10 years in certain circumstances. These include when certain members of uniformed services or the Foreign Service or employees of the intelligence community are required to move as a result of employment assignments and when taxpayers are affected by changes in employment, health, and other unforeseen circumstances in their lives. (6)

All the Housing Act provisions became effective January 1, 2009, regardless of the taxpayer's tax year end.

Qualified and Nonqualified Holding Periods

The major development introduced by the Housing Act is the segregation of the time a residence is held by a taxpayer into qualified and nonqualified holding periods. (7) For sales of residences after December 31, 2008, the Sec. 121 exclusion of gain will not apply to any gain allocated to a nonqualified holding period. The maximum amount of the Sec. 121 exclusion-S250,000 for single taxpayers or $500,000 for married taxpayers filing jointly--is not affected.

Example 1: B sells a residence with $150,000 long-term capital gain from appreciation over 60 months. During that period, 40 months are deemed to be a qualifying holding period and 20 months constitute a nonqualifying holding period. $100,000 of the gain [$150,000 x (40 / 60)] is eligible for the Sec. 121 exclusion; and $50,000 [$150,000 x (20 / 60)] is not eligible for exclusion and is subject to tax.

If the residence is held for...