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The Tax Prophet Newsletter   Issue # 23 May, 2005


In This Issue:
The Exclusion
Married TPs
Unforeseen Circumstances

The Residence Exclusion

The Exclusion

The residency exclusion provides up to a $250,000 exclusion in profits ($500,000 for joint filers) on the sale of a principal residence, as long as the taxpayer owned and lived in the residence for at least 24 of the 60-month period prior to sale. Thus, if a taxpayer lived in a home for 24 months, a later sale of the home up to 36 months later would qualify for the exclusion. This rule also applies to California income taxes.

Example: If a single taxpayer purchases a principal residence for $500,000, lives in the home for 24 months then sells it for $1,100,000 (a $600,000 gain), the taxpayer is entitled to exclude $250,000 of gain and will pay tax on the remaining $350,000. A married couple filing jointly would exclude $500,000 of gain and pay tax on the remaining $100,000.

The two-year period begins when a person acquires the principal residence by purchase, gift or inheritance. The exclusion does not apply to a second home or investment property.

Married Couples

Married couples filing jointly may exclude up to $500,000 in gain, provided:

(1) either spouse owned the residence; (2) both spouses meet the use test; and (3) neither spouse has sold a residence within the last two years.

If a married couple each owns and occupies a separate residence and files jointly, each may exclude up to $250,000 in gain.

Divorced taxpayers may tack on the ownership and use of their former spouse. Widowed taxpayers may tack on the ownership and use of their deceased spouse.

Note: If the widow is eligible to file a joint return, the full $500,000 exclusion should apply.

Unforeseen Circumstances

A partial exclusion is available if a residence is sold prior to the two-year-use requirement, because of a change in employment, health or unforeseen circumstances. Other unforeseen circumstances include: death; becoming eligible for unemployment compensation; a change in employment that leaves the taxpayer unable to pay the mortgage or reasonable basic living expenses; divorce or legal separation (husband and wife only); multiple births resulting from the same pregnancy; damage to the residence resulting from a natural or man-made disaster, or an act of war or terrorism; and condemnation, seizure, or other involuntary conversion of the property.

Example: If a married couple sold a home after 12 months due to multiple births from the same pregnancy, the exclusion would be reduced to $250,000 (50% of $500,000), provided they filed a joint return.

Military Exceptions

The 5-year limitation for military and foreign service personnel on qualified official extended duty away from home is extended to 10 years for a designated residence. The duty station must be at least 50 miles away from the residence (or the taxpayer must be ordered to reside in government quarters) for at least 90 days or an indefinite time period. Also, the definition of unforeseeable circumstances includes terrorist attacks and military reassignments.

These suspension rules apply to military, National Oceanic and Atmospheric Administration, Public Health Service and Foreign Service personnel.

Nursing Home

For those living in a nursing home, the ownership and use test is lowered to 1 out of 5 years prior to entering a facility. Time spent in the nursing home still counts toward ownership time and use of the residence.

Example: If a taxpayer owns and lives in a home for 1 year, resides in a nursing home for 10 years, then sells the residence, the exclusion will apply.

Other Taxpayers

Bankruptcy Trustee: The trustee of a debtor's bankruptcy estate may use the residency exemption since the trustee theoretically "steps into the shoes" of the debtor.

LLC: If a single-member limited liability company (which is disregarded for tax purposes) owns the residence, then the exclusion will apply.

Revocable Trust: If a revocable trust owns the residence, then the residency exclusion applies, since the grantor is considered the taxpayer under the grantor trust rules.

Irrevocable Trust: If the trust owning the residence is a non-grantor irrevocable trust, the exclusion will not apply, since the trust is considered a separate taxpayer.

Expatriates: Those expatriating the country for tax purposes under IRC Sec. 877 cannot use the exclusion.

Resident Aliens: Resident aliens are eligible to use the exclusion since they are considered U.S. taxpayers.

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All contents copyright © 1995-2005 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.