What is an "unforeseen circumstance"?

• Author: Solomon, Norman S.
• Position: Taxpayer Relief Act of 1997; taxation for sale of a personal residence

The Taxpayer Relief Act of 1997 (TRA '97) changed the taxation of gain realized on the sale of a personal residence. Under prior law, certain taxpayers age 55 and older could exclude $125,000 from the reportable capital gain realized on a residence sale. The TRA '97 enactment of Sec. 121 allowed taxpayers of any age to exclude up to $250,000 per taxpayer ($500,000 on a joint return) every two years, if they met certain conditions. Basically, a taxpayer must own and occupy a personal residence for at least two years during the five-year period preceding the sale.

Sec. 121(c) allows taxpayers to obtain partial relief when the home has not been owned and occupied for two years, if the sale is due to a change in employment, health reasons or "unforeseen circumstances." That provision anticipates that guidance will be found in regulations. Prop. Regs. Sec. 1.121-3(a) states that the definition of unforeseen circumstances will appear in several places, such as "forms, instructions, or other appropriate guidance including regulations and letter rulings."

The IRS held hearings in January 2001 to allow interested parties to comment on the proposed regulations. The AICPA, American Bar Association and others made presentations suggesting that unforeseen circumstances include the following: (1) health or change of employment of a member of the taxpayer's household; (2) changes in family circumstances; (3) unique circumstances of newly-weds who own separate houses and may not be able to meet the use tests; (4) sales caused by divorce or the break-up of a family relationship; (5) death of a co-owner or occupant; (6) changes in financial circumstances; (7) disability; and (8) changes in the use of the home. IRS personnel have indicated that they will give serious consideration to each proposal.

The IRS recently issued a worksheet in Pub. 918, Drafts of Worksheets in IRS Publications, p. 6, taken from Pub. 523, Sale of Personal Residence, that does not refer to...