In 1997 Congress enacted the law which states if you own and live in your home for two years, you can take an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) for the old “replacement residence” rules.
Unlike the previous once-in-a-lifetime exclusion for senior citizens, the new exclusion may be claimed repeatedly, but usually only once every two years.
When the law was enacted in 1997, homeowners who held property for less than two years could qualify for the following reduced exclusions; selling due to a change in employment, health reasons or “unforseen circumstances.”
However, these exclusions were loosely defined, so most people had no idea if they would qualify for a reduction. Effective December 24, 2002, the IRS issued temporary regulations, pertaining to home sales within a two year period. If the taxpayer falls within one of these safety zones, they will automatically be entitled to the appropriate exclusion of gain.
Defining the Principle Residence
For homeowners with multiple homes, the principal residence is determined by using the following factors; place of employment; where other family members live; the address used for tax returns, driver’s license, car and voter registration, bills and correspondence; and the location of the taxpayer’s banks, religious organizations or recreational clubs etc.
Once the primary residence has been established, the following, temporary “safe havens” apply:
The new place of employment must be at least 50 miles farther from the old home than the old workplace was from that home (this is the same distance rule that applies for the moving expense deduction). The employment change must occur during ownership and use of the home as a residence. According to the IRS regulations, employment is defined as “the commencement of employment with a new employer, the continuation of employment with the same employer, or the commencement or continuation of self-employment.”
A qualified person is the taxpayer, his/her spouse, co-owner or a member of the taxpayer’s household.
If a doctor recommends a change of residence for reasons of health. Of course “health” is a broad term, so the IRS has defined “health reasons” as:
- 1) advanced age-related infirmities,
- 2) a homeowner’s need to move in order to care for a family member,
- 3) severe allergies, and
- 4) emotional problems.
“Qualified individuals” includes family members who are in need of medical assistance away from the principal residence. The definition of “qualified individual” in the case of health is broader than the definition that applies to the change in place of employment and unforeseen circumstances to encompass taxpayers who sell or exchange their residence in order to care for sick family members.
In addition to the persons listed above, a qualified person for health reasons includes certain close relatives, so that sales related to caring for sick family members will qualify.
Congress allowed the IRS to define the terms of this nebulous category. So the IRS provided the following to be considered “safe harbors”:
- 1. Death;
- 2. Being terminated from employment and thus eligible for unemployment compensation;
- 3. A change in job status that results in the taxpayer being unable to pay the mortgage and reasonable basic living expenses for the taxpayer’s household;
- 4. Divorce or legal separation;
- 5. Multiple births resulting from the same pregnancy;
- 6. Involuntary conversion of the property − such as a condemnation by a governmental authority, and
- 7. Destruction of the property because of a man-made disaster, an act or war or terrorism.
Any of the first five situations listed must involve the taxpayer, spouse, co-owner, or a member of the taxpayer’s household to qualify. The regulations also give the IRS Commissioner the discretion to determine other circumstances as unforeseen.
Determining the gains
According to the IRS, “for qualifying sellers, the maximum exclusion amount of $250,000 ($500,000 for a married couple filing jointly) is limited to the percentage of the two years that the person fulfilled the requirements. Thus, a qualifying seller who owns and occupies a home for one year (half of two years) – and who has not excluded gain on another home in that time – may exclude half the regular maximum amount, or up to $125,000 of gain ($250,000 for most joint returns). The proportion may be figured in days or months.”