Real Estate Internet Talk Soup:
THE REAL ESTATE DISCUSSION GROUP
Volume 8, Number 25 December 31, 2002
IN THIS ISSUE:
1. IRS Issues Final Regs on Exclusion of Gain from Sale of Principal Residence
2. Temporary Regs Issued on Reduced Maximum Exclusion of Gain from Sale of
Principal Residence
3. Proposed Regs Issued on Reduced Maximum Exclusion on Sale of Principal
Residence
1. IRS Issues Final Regs on Exclusion of Gain from Sale of Principal Residence
The IRS has issued final regulations (T.D. 9030) on the exclusion of gain
from the sale of a principal residence.
The final regs , which are effective December 24, 2002, reflect changes to
the Taxpayer Relief Act of 1997, as amended by the Internal Revenue Service
Restructuring and Reform Act of 1998. The final regs include changes that
incorporate several public comments on the proposed regs (REG-105235-99),
including the treatment of gain on property used for both business and
residential purposes and allocation of gain. (For a news release on the final
regs, see Doc 2002-27964 (39 original pages) . For the full text of
REG-105235-99, see Doc 2000- 26108 (6 original pages), or 2000 TNT 200-43.)
The final regs explain how to determine if a home is a principal residence
and when gain from the sale of vacant land used as part of the residence may be
excluded. The regs also cover when and how to allocate gain between residential
and business uses, how the exclusion applies to joint owners who aren't married,
and how to fulfill the requirement that the owner used the home as a principal
residence for two of the five years before the sale.
The final regs do not provide a bright-line test to identify a property as
a principal residence if the seller has several residences, as requested by
several commentators. Instead, the final regs continue to provide that the
residence an owner uses for most of the year will ordinarily be considered the
principal residence. However, the regs include a nonexclusive list of factors
that are relevant in identifying a property as a principal residence.
Addressing other commentators' requests for clarification on the
circumstances in which vacant land surrounding a residential structure would be
treated as part of the residence, the final regs specify that the vacant land
must be adjacent to the land containing a dwelling and that the sale or exchange
of the vacant land must satisfy section 121's requirements. Only one maximum
limitation amount of $250,000 will apply to combined sales of the primary
residence and adjacent vacant land. If the sale or exchange of the residence and
vacant land occur in different tax years, gain from the residence, up to the
maximum limit, is excluded first.
The final regs, however, do not adopt several commentators' requests for
exceptions to the occupancy requirement, noting that no authority exists under
section 121. Moreover, the IRS dismissed the request made by several
commentators that the regulations specify a maximum period of time that would be
considered a short, temporary absence and be considered for satisfying the
two-year requirement. It said that the consideration of whether an absence is
short and temporary is a factual determination.
The IRS reconsidered the allocation rules for residential and business, or
mixed-use, property. It now provides that section 121 will not apply to the gain
allocable to any portion of the property sold or exchanged that does not satisfy
the use requirement if the nonresidential portion is separate from the dwelling
unit. In that regard, the regs provide a "dwelling unit" has the same meaning as
in section 280A(f)(1). Also, an owner must use the same method to allocate the
basis and amount realized between the business and residential parts of the
property as the owner used to allocate the basis for depreciation purposes, if
applicable.
The final regs also adopt a commentator's suggestion that if a residence is
held by a trust, the taxpayer is treated as the owner and seller of the
residence during the time the taxpayer is treated as the owner of the trust or
the part of the trust that includes the residence under sections 671-679. The
final regs provide that each unmarried individual who jointly owns a principal
residence may be eligible to exclude from gross income up to $250,000 of gain
that is attributable to each individual's property interest.
Individuals who have used or owned a residence for less than two of the
five years before the sale or exchange or who have excluded gain from another
sale or exchange in the past two years may qualify for the reduced maximum
exclusion. However, the sale or exchange must be due to a change in the place of
employment, health, or unforeseen circumstances. Because the rules are
extensive, Treasury and the IRS have issued proposed and temporary regs to
provide time for the public to formulate comments. (For summaries of T.D. 9031
and REG- 138882-02, see Doc 2002-27965 (20 original pages) and Doc 2002-27979 (5
original pages).)
The IRS did not adopt in the final regs suggestions to allow a surviving
spouse to exclude up to $500,000 of gain if the sale or exchange of the marital
home occurs within a year of the other spouse's death and if section 121's
requirement are met. The regs note that the exclusion is only available to
spouses who file a joint return and that a surviving spouse may file a joint
return with the decedent only for the year in which the death occurred.
The final regs also address partial interests, elections under sections
121(d)(8) and (f), reporting requirements, the retroactive application of the
regs, audit protection, and the section 121 exclusion in bankruptcy cases. (For
the full text of T.D. 9030 (23 Dec 2002), see Doc 2002-27964 (47 original pages)
or 2002 TNT 247-3.)
2. Temporary Regs Issued on Reduced Maximum Exclusion of Gain from Sale of
Principal Residence
The IRS has provided guidance, in addition to related final regs, in the
form of temporary regs (T.D. 9031) on the application of the reduced maximum
exclusion of gain from the sale or exchange of a principal residence for
purposes of the requirements of section 121.
The text of the temporary regs, which are effective December 24, 2002, also
serves as the text of proposed REG-138882-02. (For a summary of the proposed
regs, see Doc 2002-27979 (5 pages). (For a summary of the related final regs
(T.D. 9030), see Doc 2002-27964 (39 original pages).) The temporary regs amend
section 121(c) relating to the exclusion of gain from the sale or exchange of
the principal residence of an individual who hasn't owned and used the property
as a principal residence for two of the preceding five years or who has excluded
gain on the sale or exchange of a principal residence within the preceding two
years.
The temporary regs provide a reduced maximum exclusion limitation for a
qualified taxpayer. This limitation applies only if there is a change in place
of employment, health, or unforeseen circumstances. For each of the three
grounds for claiming a reduced maximum exclusion, the temporary regs provide a
general definition and one or more safe harbors. If a safe harbor applies, the
individual's primary reason for the sale or exchange is deemed to be a change in
place of employment, health, or unforeseen circumstances.
For purposes of the change in employment safe harbor, the distance rule
tracks with the distance rule that applies for the moving expense deduction
under section 217(c)(1). A sale will be considered because of health if the
primary reason is related to a disease, illness, or injury of a qualified
person. A definition of a qualified person is provided. In the case of a sale or
exchange by reason of health, the definition of a qualified individual
encompasses those who sell or exchange their residence to care for sick family
members.
The temporary regs also provide that an involuntary conversion of the
residence, a disaster, war or terrorism that results in a casualty to the
residence, all qualify as safe harbors as unforeseen circumstances. In the case
of a qualified individual, events include death, the unexpected cessation of
employment, divorce or legal separation, or multiple births from the same
pregnancy. The commissioner may designate other events in published guidance or
in a ruling directed to a specific taxpayer. These situations will be addressed
under a facts-and-circumstances test. The temporary regs also address the
retroactive application and audit protection. (For the full text of T.D. 9031
(23 Dec 2002), see Doc 2002-27965 (22 original pages) or 2002 TNT 247-5.)
3. Proposed Regs Issued on Reduced Maximum Exclusion on Sale of Principal
Residence
The IRS has issued proposed regulations (REG-138882-02) on the reduced
maximum exclusion of gain from the sale or exchange of a principal residence
that occurs before the owner has met section 121's requirements.
The IRS simultaneously issued temporary regs (T.D. 9031) that more
thoroughly define change in place of employment, health, or unforeseen
circumstances, which are exceptions to section 121's requirements that entitle
eligible taxpayers to an exclusion in a reduced maximum amount. (For a summary
of T.D. 9031, see Doc 2002- 27965 (20 original pages); for a summary of related
final regs (T.D. 9030), see Doc 2002-27964 (39 original pages).) The text of the
temporary regs also serves as the text for the proposed regs. These regs are
effective December 24, 2002.
Comments and requests for a public hearing, which are due by March 25,
2003, must be sent to Internal Revenue Service, CC:ITA:RU (REG-138882-02), Room
5226, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Alternatively,
comments may be submitted electronically to the IRS Web site at
www.irs.gov/regs. (For the full text of REG-138882-02 (23 Dec 2002), see Doc
2002-27979 (5 original pages) or 2002 TNT 247-6.)
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