Spousal sales may defer recognition of gain.

• Author: Lusby, Roger W., III

With divorces so prevalent in today's society, it is not uncommon to encounter a situation in which a client plans to remarry and both the client and his new spouse own personal residences.

In many situations, the new spouse will decide to sell her personal residence and move into the husband's residence. Without any planning, the new spouse would be required to recognize the gain on the sale of her personal residence since the sale proceeds were not properly rolled over. A bona fide sale between the spouses may resolve this issue by deferring recognition of the gain under Sec. 1034.

With a bona fide spousal sale, the wife's purchase of an interest in the personal residence owned by the husband should qualify as a reinvestment, since the wife will occupy the home as her principal residence.

In order to defer the entire gain, the interest must be greater than the adjusted sales price (as defined in Sec. 1034(b)) and the interest must be purchased within the applicable time period. The husband should not have to recognize any gain on the sale of the home under Sec. 1041(a)(1) since it is a sale between spouses. (Note that Section 421(a) of the Tax Reform Act of 1994 added Sec. 1041 to the Code, which provides that no gain or loss shall be recognized on a property transfer from an individual to a spouse. Sec. 1041 generally applies to transfers after July 18, 1984, in tax years ending after such date.

With a spousal sale, the requirements under Sec. 1034(a) appear to be met, since the new residence is purchased and used by the taxpayer as her principal residence. Pursuant to Regs. Sec. 1.1034-1(e), the new spouse would be required to reduce her basis in the new residence by the gain realized on the sale of her former, residence.

The use of a spousal sale cannot be guaranteed since the IRS, in Rev. Proc. 94-3, has ruled that it will not issue rulings or determination letters on whether property qualifies as the taxpayer's principal residence for Sec. 1034 or 121 purposes.

Despite this...