Taxing Lessons From Court Decisions

Home Sale Exclusion

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Generally, under Section 121 of the Internal Revenue code, you can exclude up to $250,000 ($500,000 if you’re married filing jointly) of the gain on the sale of your personal home, as long as you lived in the home two or more years during the five-year period before the sale.

But what happens when you only own part of the home? Do you have to pro-rate the exclusion?

In this opinion (Summary Opinion 2010-68, Hsu), the taxpayer, who was single, owned 50% of her personal residence. The total gain on the sale was $529,289. She reported one-half of the gain on her tax return and applied the $250,000 exclusion against that amount. The IRS issued a notice of deficiency, saying that as a 50% owner she was entitled to only 50% of the exclusion, or $125,000.

The court sided with the taxpayer. Section 121 contains no limitation for partial owners of a principal residence. Regulation 1.121-2(a)(2), (4) (example 1) provides that unmarried joint owners each owning a 50% interest in a principal residence are each entitled, upon sale, to the full limitation amount of $250,000 on their portions of the gain.

Taxing Lesson: Assuming IRS notices are correct could cost you money.

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