"Unforeseen Circumstances" Exclusion from Gain on Sale of Home: Regulations and Private Letter Rulings Offer Examples of Situations the IRS Has Approved as Qualifying for Partial Exclusion of Gain
[ILLUSTRATION OMITTED] Despite the recent downturn in the American housing market, one of the highest-value assets owned by most taxpayers remains their home. While many taxpayers have seen the value of their home decline, those in locales where home values have remained relatively strong--such as parts of some Southern and Midwestern states--could still realize a gain upon the sale of their home. Those now buying homes in depressed regions at what they hope are market-bottom prices will likely realize a gain after markets recover. Single taxpayers or those married filing separately generally can exclude up to $250,000 of the gain from the sale or exchange of a home ($500,000 for married taxpayers filing jointly). This exclusion may be taken once every two years if the taxpayers have owned and used the property as a principal residence for a period of (or periods totaling) at least two years during the five-year period ending on the date of the sale or exchange. Taxpayers who don't meet these conditions can qualify for a reduced exclusion under IRC [section] 121(c) if the sale or exchange is because of a change in place of employment, health or "unforeseen circumstances." REDUCED EXCLUSION SAFE HARBORS Employment. Treas. Reg. [section][section] 1.121-3(c)(1) and (2) provide that a sale or exchange is by reason of a change in place of employment if (1) the change occurs during the period when the taxpayer owns and uses the property as a principal residence and (2) the taxpayer's or other qualified individual's new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment. If there was no former place of employment, the distance between the qualified individual's new place of employment and the residence sold or exchanged must be at least 50 miles. The new place of employment may be with the same or a different employer or can include the beginning or continuation of self-employment (Treas. Reg. [section] 1.121-3(c)(3)). A qualified individual is 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 (Treas. Reg. [section] 1.121-3(f)). Health. A sale or exchange is for health reasons if it is primarily to provide medical diagnosis, treatment or care for a qualified individual's disease, illness or injury or to provide personal care. Qualified individuals include those for purposes of a change of employment, plus their family members and certain other relatives. A change of residence must be more than merely beneficial to general health or well-being unless recommended by a physician. See Treas. Reg. [section] 1.121-3(d). Unforeseen circumstances. Unforeseen circumstances are defined by Treas. Reg. [section] 1.121-3(e)(1) as events the taxpayer could not reasonably have anticipated before purchasing and occupying the residence. Specific-event safe harbors are provided in Treas. Reg. [section] 1.121-3(e)(2): involuntary conversion of the residence; disasters or acts of war or terrorism damaging the residence; or a qualified individual's death, unemployment (if eligible for unemployment compensation), change in employment status that results in an inability to pay housing costs and basic living expenses, divorce or legal separation under a decree of divorce or separate maintenance, or a multiple birth. These, however, are hardly all the common life events that can result in the sale or exchange of a home, such as marriage, adoption or other circumstance that results in the addition of dependents to the family. Despite not being specified as safe harbor events, circumstances such as these and others may still qualify as unforeseen. Determining whether fact patterns exhibit the level of unforeseeability necessary to qualify as unforeseen circumstances requires taxpayers and practitioners to exercise their best judgment. …