A partial home sale exclusion may be available for taxpayers who fail to qualify for the two-out-of-five-year ownership and use rule, or who have previously used the exclusion on the sale of another home within the two-year period ending on the sale date of the current home.
The maximum gain that can be excluded is equal to the full $250,000 or $500,000 exclusion times a fraction having as its numerator the shorter of:
- The aggregate periods of ownership and use of the home by the taxpayer as a principal residence during the five years ending on the sale date; or,
- The period of time after the last sale to which the exclusion applied, and before the date of the current sale, and having two years (or its equivalent in months or days) as its denominator.
Observation: Thus, the maximum excludible gain is not a fraction of the gain on the sale if the gain is less than the maximum amount of the full $250,000 exclusion ($500,000 for married couples who file jointly). It is a fraction of $250,000 (or $500,000). In many cases, this means that a taxpayer who is eligible for a partial exclusion will be eligible to exclude the full amount of his gain.Example 1: Your client, a single taxpayer, sold her cooperative apartment on Feb. 1, 2003, after owning and using it as her principal residence for only six months. It was the first principal residence that she had ever owned. She had a gain of $50,000 on the sale.
If she qualifies for a partial exclusion, she will be able to exclude the entire $50,000 of her gain since this is less than $62,500 (6/24 of the maximum exclusion of $250,000 that she would be able to take if she were entitled to the full exclusion). The fraction equals six months (the period that she owned and used the cooperative apartment as her principal residence over 24 months, the monthly equivalent of two years).
To qualify for the partial exclusion, the taxpayer’s primary reason for the sale, based on the facts and circumstances, must be due to:
- A change in place of employment;
- Reasons of health; or,
- Unforeseen circumstances.
Temporary regulations explain each of the three conditions and provide safe harbors for satisfying them. If a safe harbor doesn’t apply, then the determination of whether a partial exclusion should be allowed depends on all the facts and circumstances. Key facts and circumstances taken into account are:
- Whether the sale or exchange and the circumstances giving rise to the sale or exchange are proximate in time;
- Whether the suitability of the property as the taxpayer’s principal residence materially changes;
- Whether the taxpayer’s financial ability to maintain the property materially changes;
- Whether the taxpayer uses the property as the taxpayer’s residence during the period of the taxpayer’s ownership of the property;
- Whether 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; and,
- Whether the circumstances giving rise to the sale or exchange occur during the period of the taxpayer’s ownership and use of the property as the taxpayer’s principal residence.
When partial exclusion is availableA sale or exchange is considered to be by reason of a change in place of employment if, in the case of a qualified individual, the primary reason for the sale or exchange is a change in the location of the individual’s employment.
Under a safe harbor provided in the temporary regulations, this condition is treated as met if the 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 taxpayer does not have a former place of employment, the new place of employment must be at least 50 miles from the residence sold or exchanged for the safe harbor to be met. In addition, for the safe harbor to apply, the change in place of employment must occur during the period of the taxpayer’s ownership and use of the home as his principal residence.
Employment includes the beginning of employment with a new employer, the continuation of employment with the same employer, and the beginning or continuation of self-employment.
Thus, if you continue to work for the same employer, but the location of your place of employment changes, you may be able to qualify for the partial exclusion if you sell your principal residence. Similarly, if you are self-employed, you may qualify if you start working at a different location.
For purposes of determining whether a change in place of employment qualifies for a partial exclusion, the term "qualified individual" means the taxpayer; the taxpayer’s spouse; a co-owner of the residence; or a person whose principal place of abode is in the same household as the taxpayer.
Example 2: Your client, who is single, lived in a rented apartment for six years before he bought a house on Feb. 1, 2002, which he used as his principal residence until he sold it. At the time he was employed as a data processor at Xerxes Corp., which was located 15 miles from his principal residence.
On Dec. 1, 2002, he lost his job at Xerxes and started looking for a new job. On Jan. 15, 2003, he obtained a job with Yorick Inc., which is located 70 miles from his residence.
He sells his residence on April 1, 2003, and has a $100,000 gain on the sale due to the rapid increase in values of homes in his neighborhood, plus the fact that, as a result of his own labor, he made substantial improvements in the house while he lived there.
He owned and used the house as his principal residence for 14 months. Accordingly, he will be able to exclude the entire gain of $100,000 from the sale since his new job is more than 50 miles farther from his principal residence than his old job was, and the gain is less than $145,833 (14/24 of the maximum full exclusion of $250,000).
Example 3: The same facts apply as in Example 2, except that the principal residence is only 60 miles from the location of your client’s new job. The safe harbor doesn’t apply since the new job location is not at least 50 miles farther from his principal residence than his old job location was.
However, your client’s principal reason for selling his house was the fact that he had to take a new job 60 miles away from his residence, and:
- He did not anticipate this happening when he bought the house, and
- The sale took place soon after he took the new job.
It is therefore likely that, under the facts and circumstances test, your client would still qualify for the exclusion.Observation: If, in Example 3, your client were treated as not having a former place of employment when he took the new job, the safe harbor would apply since the new job was located 60 miles from his principal residence. While your client had lost his old job about a month-and-a-half before he got a new job, it’s unlikely that he would be treated as not having a place of employment for purposes of the safe harbor.
While the temporary regulations don’t define what is meant by not having a place of employment, the test for allowing a moving expense deduction under IRC § 217 when a taxpayer begins work at a new principal place of work is similar to the safe harbor for the partial exclusion.
Under Reg § 1.217-2(c)(2), an individual who does not have a place of employment includes an individual who is re-entering the labor market after a substantial period of unemployment or part-time employment. While the regulation doesn’t define when a period of employment is "substantial," Rev. Rul. 78-174, 1978-1 CB 77 said that a two-month period wasn’t substantial.
Example 4: Your client, a construction worker and a single taxpayer, was told in June of 2002 that his job would not last for more than eight months and then he would be laid off indefinitely. Nevertheless, on Aug. 1, 2002, he bought a house for $250,000 that he used as his principal residence from that date until he sold it.
The house was just five miles from his job location. He had never owned a principal residence before. The house was in severe disrepair (a "handyman’s special’’) and was worth about $150,000 less than houses of a comparable size and age in his neighborhood. He spent $50,000 for necessary supplies and materials and repaired the house himself.
He lost his job on Jan. 31, 2003. On March 1, 2003, he got a new job that was 35 miles from his principal residence, and was only 30 miles farther from it than his old job was. On May 1, 2003, he sold his principal residence at a gain of $100,000.
The safe harbor doesn’t apply since the new job wasn’t at least 50 miles farther from his principal residence than his old job was. It’s also unlikely that your client will qualify for a partial exclusion under the facts and circumstances test, since, at the time he bought the house, the circumstances giving rise to the sale were foreseeable. Your client knew when he bought the house that he would be losing his job in just a few months and might have to relocate to get another job.
Example 5: The same facts apply as in Example 4, except that your client’s new job is 60 miles farther from his principal residence than his old job. The safe harbor will apply since the change in place of employment occurred while he used and owned the house as his principal residence.
Accordingly, he will be entitled to exclude $93,750 of his $100,000 gain (9/24 of the maximum exclusion of $250,000, since he owned and used the house as his principal residence for nine months). The fact that he knew at the time that he bought the house that he would lose his job in a few months doesn’t affect his right to the partial exclusion when a safe harbor applies.
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