Does the taxpayer meet the use requirement to qualify for the principal residence gain exclusion on the sale of a home?
Taxpayer Says: Use of the home meets the requirements to qualify for the $500,000 gain exclusion on the sale.
Internal Revenue Service Says: The taxpayers alternated between residences in two states. The home sold was not the principal residence and does not qualify for the exclusion.
From Internal Revenue Code Section 61(a)(3): Gain realized on the sale of property is generally included in a taxpayer’s income.
From Internal Revenue Code Section 121(a): A taxpayer may exclude from income gain on the sale or exchange of property if the taxpayer has owned and used the property as the taxpayer’s principal residence for periods aggregating two of the five years immediately preceding the sale.
From Internal Revenue Code Section 121(b)(2): A married couple filing a joint return may claim a $500,000 exclusion on the sale or exchange of their principal residence if certain conditions are met.
From Federal Tax Regulation 1.121-1(b)(2): If a taxpayer alternates between two properties, using each as a residence for successive periods of time, the property the taxpayer uses a majority of the time during the year ordinarily will be considered the taxpayer’s principal residence. Besides the use of the property, there are other relevant factors in determining a taxpayer’s principal residence. These relevant factors include (i) the taxpayer’s place of employment, (ii) the principal place of abode of the taxpayer’s family members, (iii) the address listed on the taxpayer’s Federal and state tax returns, driver’s license, automobile registration and voter registration card, (iv) the taxpayer’s mailing address for bills and correspondence, (v) the location of the taxpayer’s banks, and (vi) the location of religious organizations and recreational clubs with which the taxpayer is affiliated.
From Federal Tax Regulation 1.121-1(c): Taxpayers must occupy the residence for 24 full months or for 730 days to meet the 2-year use requirement. Short temporary absences, such as for vacation or other seasonal absence, are counted as periods of use.
THE CAUSE OF THE DISPUTE
To qualify for the exclusion of gain on the sale of your home (up to $500,000 when you’re married filing a joint return), you have to have owned and lived in the house for two of the five years prior to the sale. In addition, during the two years preceding the sale, you can’t have claimed the home exclusion on another home.
One area of dispute over claiming the exclusion arises when you own or live in more than one home during the same time period. Because the tax code does not define “principal residence”, determining which home qualifies for the exclusion depends on other facts that can support the use requirement.
In this case, the taxpayers owned homes in both Iowa and Nebraska. They considered the Iowa home their principal residence and believed it eligible for the exclusion when they sold it in 2005, as they spent the majority of time there attending personal and family events and obligations. Numerous family members lived in Iowa, as did their doctors and lawyers. Their cars were registered in Iowa, they filed for Iowa homestead property tax credits, and they purchased another home in Iowa after selling the house in question.
The IRS says the taxpayers lived in Nebraska and visited Iowa, and so the sale of the Iowa home does not qualify for the exclusion. The IRS points to the fact that the taxpayers had a business in Nebraska and filed annually for a Nebraska liquor license, which is only issued to Nebraska residents.
In addition, the taxpayers filed federal and Iowa state income tax returns for 2000 with an Iowa address. However, the returns for 2001 through 2004 listed the address in Nebraska, and Nebraska state returns for 2002 and 2003 were filed as residents using a Nebraska address. The taxpayers did not file a Nebraska State tax return for 2000, 2001, 2004 or 2005.
Other factors include the receipt of mail, which the taxpayers received at both homes. The taxpayers were not registered to vote in either state.
WHAT WOULD YOU DECIDE?
Make your selection, then see “The Court’s Decision” below for a full explanation
THE COURT’S DECISION
HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.
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