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Gain Exclusion Tips Under IRS Section 121 Upon Sale of Primary Residence

[PCQ Note: The summary below is for basic informational purposes and should not be used or relied upon as legal or tax advice in your particular situation. If you need specific information, you should contact your tax attorney, CPA or other expert familiar with these issues. A much more in-depth discussion of this law can be found on the Premium Members side.]

The basic requirements for claiming an exclusion of gain from the sale of a principal residence are relatively straightforward in most cases. An individual taxpayer may exclude up to $250,000 of the gain if the property is his/her principal residence for at least two of the five years preceding date of the sale. 1 The requirements breakdown as follows:

(1) The property must be the principal residence of the taxpayer for two of the preceding five years. To be a principal residence it must be the taxpayer's "main home", which is generally where a person lives most of the time. Factors the IRS considers are place of employment; location of family members' main home; mailing address for bills and correspondence; address listed on tax returns, driver's license, car registration, and voter registration; location of banks the taxpayer uses; and the location of the taxpayer’s recreational clubs and religious organizations.

(2) The two years may consist of either 24 consecutive months or 730 accumulated days during the five year period ending on the date of sale.

(3) The ownership test simply requires that the taxpayer owned the property for at least 2 years during the five year period.

(4) The use test requires that the taxpayer live in the home as his/her primary residence for at least 2 years during the five year period.

(5) The exemption is not available if the taxpayer excluded gain from the sale of another home under Section 121 within the 2-year period ending on the date of second sale. In other words, you can only claim the exclusion once every two years.

(6) In 2002 the IRS clarified that parcels of vacant land adjacent to the primary residence that have been used as part of the residence may also receive Section 121 treatment if the sale of the vacant land occurs within two years before or after the sale of the principal residence.

(7) A taxpayer and his/her spouse may exclude up to $500,000 of gain only if all of the following occur: (a) they are married and file a joint return for the year of sale, (b either (or both) the taxpayer or his/her spouse meet the ownership test, (c) both the taxpayer and his/her spouse meet the use test, and (d) neither the taxpayer nor his/her spouse excluded gain from the sale of a principal residence during the prior two years.

© 2010 Phillip C. Querin, QUERIN LAW GROUP LLC. No portion may be copied or reproduced without the express written consent of the author.

1 There are certain "unforeseen circumstance" exceptions in the regulations.

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