Home seller's gain: New regs favorably interpret 1997 taxpayer relief act.

• Author: Josephs, Stuart R.
• Position: Federal Tax

On Dec. 24, the IRS published final, temporary and proposed regulations regarding the exclusion of gain from the sale or exchange of a principal residence under IRC Sec. 121. These regulations generally apply to sales or exchanges after Dec. 23, 2002.

However, taxpayers may elect to apply these new regulations for sales or exchanges after May 6, 1997, if the statute of limitations for claiming credits or refunds has not expired.

This election is made by filing a return for the tax year of the sale or exchange of the taxpayer's principal residence that excludes the gain from gross income. If a return for such a year has been filed, this election is made by filing an amended return.

Audit Protection

The final regulations provide that the IRS will not challenge a taxpayer's position that a sale or exchange before Dec. 24, 2002--but after May 6, 1997--qualifies for the exclusion if the taxpayer has made a reasonable, good-faith effort to comply with Sec. 121's requirements. Compliance with the regulations proposed in 2000 generally will be considered a reasonable, good-faith effort.

The temporary (and proposed) regulations provide that the IRS will not challenge a taxpayer's position that a sale or exchange before Dec. 24, 2002-- but after May 6, 1997--qualifies for the reduced exclusion if the taxpayer has made a reasonable, good-faith effort to comply with Sec. 121(c)'s requirements and if the sale or exchange otherwise qualifies under Sec. 121.

Mixed-use Residences

A mixed-use residence is one that is used partially for residential and business purposes. Under the regulations proposed in 2000, only the gain allocable to the residential portion could be excluded under Sec. 121 if a mixed-use residence was sold or exchanged.

However, under the final regulations, no allocation of gain is required if both the residential and business portions of the property are within the same dwelling unit. But Sec. 121 will not apply to the gain to the extent of any post-May 6, 1997 depreciation adjustments.

Example 1: On July 1, 1999, Joe moves into a house that he owns and had rented to tenants since July 1, 1997. His depreciation deductions were $14,000 for the period that he rented this property. After using the property as his principal residence for two years, Joe sells it on Aug. 1, 2001, and realizes a $40,000 gain. (Joe has no other 2001 Sec. 1231 or capital gains or losses.) Only $26,000 ($40,000 gain less the $14,000 depreciation deductions) may be...