Exclusion of Gain


Courtesy of Chicago Title.

Different rules on the exclusion of gain on the sale of a home apply depending upon whether the sale took place before May 7, 1997, or after May 6, 1997. The changes were made by the Taxpayer Relief Act (TRA) of 1997 (P.L. 105-34, enacted August 5, 1997). 

Unless he or she elects otherwise, a taxpayer may exclude from income up to $250,000 realized on the sale or exchange of a residence. The taxpayer must have owned and occupied the residence as a principal residence for an aggregate of at least two of the five years before the sale or exchange (IRC section 121). The exclusion is not available to nonresident aliens subject to IRC section 877(a) (expatriation to avoid tax). 

Married individuals. Excludable gain is increased to $500,000 for married individuals who file jointly if (1) either spouse meets the ownership test; (2) both spouses meet the use test; and (3) neither spouse is ineligible for exclusion by virtue of a sale or exchange of a residence within the last two years. (IRC section 121(b)). The exclusion is determined on an individual basis. 


Depreciation: The exclusion does not apply, and gain is recognized, to the extent of any depreciation allowable with regard to the rental or business use of a principal residence after May 6, 1997. 


Proration of exclusion. If a taxpayer does not meet the ownership or residence requirements, a pro rata amount of the 250,000 or $500,000 exclusion applies if the sale or exchange is due to a change in place of employment, health reasons, or unforeseen circumstances. In those cases, the available exclusion is the amount that bears the same ratio to $250,000 (or $500,000) as the shorter of (1) the aggregate periods during which the ownership or residence requirements were met during the five-year period, ending on the date of sale, or (2) the period after the date of the most recent prior sale or exchange to which the exclusion applied and before the date of sale or exchange, bears to two years. (IRC section 121(c)) (IRS regulations will determine the extent to which the exclusion may be prorated due to a sale or exchange involving unforeseen circumstances). 


Sales before August 5, 1999. A special rule provides that the exclusion may still be claimed even though the taxpayer does not satisfy the ownership and use test or the special circumstances requirements. To trigger the special rule, the taxpayer must have held the residence on August 5, 1997 (the date of enactment of TRA '97), and the sale or exchange must occur during the two-year period that began on August 5, 1997. 


Ownership and use of prior residences. In determining the period of ownership of a current residence, taxpayers may include periods of ownership and use of all prior residences RPM90 on which gain was rolled over to the current residence under former IRC section 1034 (IRC section 121(g)). 


Divorced and widowed individuals. Let's assume that a man owned a residence before marrying his spouse. They divorce and the house is transferred to the wife as part of the divorce settlement. Under this scenario, the time during which the husband owned the residence is added to the wife's period of ownership. (IRC section 121(d)(3)). Should the couple stay married until the husband's death, the wife's period of ownership of the residence includes the period during which her deceased husband owned the residence. (IRC section 121(d)(2)). 


Involuntary conversions. For purposes of the exclusions, the destruction, theft, seizure, requisition or condemnation of property is treated as a sale or exchange of the residence. (IRC section 121(d)(5)). 
Co-ops. For tenant-stockholders of cooperative housing corporations, the residence ownership requirements apply to the ownership of stock in the corporation; the use requirements apply to the house or apartment that the stockholder was entitled to occupy. (IRC section 121(d)(4)). 


The preceding summary of the P.L. 105-34 is provided for informational purposes only. For a more comprehensive understanding of the legal/tax consequences of the Taxpayer Relief Act, appropriate consultation with an attorney and/or CPA is strongly recommended, even though there may be charges associated with such consultation. 

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