Home seller's gain: new regs favorably implement reduced maximum exclusion. (Federal Tax).

The March/April 2003 issue of California CPA discussed some provisions in the final, temporary and proposed regulations published in late 2002 regarding the exclusion of gain from the sale or exchange of a principal residence under IRC Sec. 121. Below are some additional rules.

Under Sec. 121(c), a reduced maximum exclusion is available if a taxpayer sold or exchanged property owned and used as his principal residence for less than two of the preceding five years or excluded gain on a principal residence within the preceding two years. This reduced exclusion applies only if the sale or exchange is primarily due to a change in place of employment, health or unforeseen circumstances.

Change in Place of Employment

Under the temporary (and proposed) regulations, this is a change in employment location of a "qualified individual."

Employment is defined as beginning work with a new employer; continuing employment with the same employer; or beginning or continuing self-employment.

A "qualified individual" is the taxpayer, the taxpayer's spouse, a co-owner of the residence or a person whose principal abode is in the same household as the taxpayer.

Under a safe harbor, the primary reason for the sale or exchange is deemed to be a change in place of employment if a qualified individual's new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment.

If the individual was unemployed, the distance between the new place of employment and the residence sold or exchanged must be at least 50 miles.

This safe harbor applies only if the change in place of employment occurs during the period of the taxpayer's ownership and use of the property as his or her principal residence.

Health

Under the temporary (and proposed) regulations, a sale or exchange is due to health if the taxpayer's primary reason for the sale or exchange is:

* To obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of a qualified individual's disease, illness or injury; or

* To obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury.

A sale or exchange that is merely beneficial to an individual's general health or well-being is not a sale or exchange due to health.

Under a safe harbor, the primary reason for the sale or exchange is deemed to be health if a physician recommends a residence change for health reasons.

"Qualified individuals" are the same as under "Change of in Place of Employment," plus certain relatives of these individuals. This broader definition encompasses taxpayers who sell or exchange their residences to care for sick relatives.

Unforeseen Circumstances

Under the temporary (and proposed) regulations, a sale or exchange is due to unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence.

A taxpayer's primary reason for the sale or exchange is deemed to be unforeseen circumstances if one of the following safe harbors occurs during the taxpayer's ownership and use of the property:

1. The involuntary conversion of the residence;

2. Natural or man-made disasters or acts of war or terrorism resulting in a casualty to the residence;

3. Death;

4. The cessation of employment as a result of which the individual is eligible for unemployment compensation;

5. A change in employment or self-employment status that results in the taxpayer's inability to pay housing costs and reasonable basic living expenses for the taxpayer's household;

6. Divorce or legal separation under a decree of divorce or separate maintenance;

7. Multiple births resulting from the same pregnancy; or

8. An event determined by the commissioner to be an unforeseen circumstance to the extent provided in published guidance of general applicability or in a ruling directed to a specific taxpayer.

Safe harbors Nos. 3-7 apply in the case of a "qualified individual" as defined under "Change in Place of Employment."

Facts and Circumstances

If the taxpayer does not qualify for a safe harbor, factors that may be relevant in determining the taxpayer's primary reason for the sale or exchange include the extent to which:

* The sale or exchange and the circumstances giving rise to the sale or exchange are proximate in time;

* The property's suitability as the taxpayer's principal residence materially changes;

* The taxpayer's financial ability to maintain the property materially changes; and

* The circumstances giving rise to the sale or exchange are not reasonably foreseeable when the taxpayer begins using the property as the taxpayer's principal residence.

Stuart R. Josephs, CPA, has a San Diego-based Tax Assistance Practice (TAP) specializing in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation, can be reached at [phone] or at [e-mail].