Adoption requirements qualified as unforeseen circumstances for principal residence exclusion.

• Author: O'Driscoll, David

In a recent ruling, a taxpayer qualified for a reduced principal residence exclusion when she sold a principal residence less than two years after purchasing it so that she could meet state adoption requirements.

Facts

After purchasing and moving into her principal residence with her sons, Y decided to adopt an orphan girl from a foreign country. However, under state law, she could not adopt a girl unless she had a separate sizable bedroom. Thus, Y could not pass the home study at the principal residence (the first step toward adoption) because she could not provide a girl with a separate bedroom.

Y was also informed that once the home study begins, all information has to be consistent throughout the entire adoption process, or the home study inspections and reviews would have to be completely redone. Further, Y is currently in the military and was scheduled to be transferred to a new post of duty in the summer or the fall. Thus, Y had to start and complete the adoption process before the transfer; if not, the entire adoption process must start over.

Accordingly, Y decided to rent a larger home with an additional room in which a girl could have her own bedroom. She sold the principal residence, which she had used and owned as a principal residence for less than two years, and moved into the rented residence. Y used the rented residence to provide the required information for the home study.

Analysis

Under Sec. 121(a), gross income does not include gain from the sale or exchange of a residence if, during the five-year period ending on the date of the sale or exchange, the taxpayer has owned and used the residence as a principal residence for periods aggregating two years or more. The full exclusion is available only once every two years (Sec. 121(b)(3)).

The maximum exclusion amount is $500,000 if(1) a husband and wife file a joint return for the tax...