Growing family qualifies for reduced home-sale exclusion

Plain-English summary

A married couple bought a two-bedroom condominium while they had one child. One bedroom also served as the husband's home office and a guest room. After the purchase, the wife became pregnant and the couple had a second child, making the residence materially less suitable for the family. They moved out and sold the condominium before meeting the normal two-year ownership and use requirements. The IRS treated the changed family circumstances as unforeseen and allowed the gain to qualify for the reduced maximum exclusion under IRC § 121(c).

Ruling snapshot

• Question: May the couple claim a partial home-sale gain exclusion after an unexpected second child led them to sell before two years?
• Outcome: Approved for the reduced maximum exclusion
• Key authorities: IRC § 121(c); Treas. Reg. § 1.121-3

Full text (IRS public release)

Internal Revenue Service                                  Department of the Treasury
                                                          Washington, DC 20224

Number: 201628002                                         [Third Party Communication:
Release Date: 7/8/2016                                    Date of Communication: Month DD, YYYY]
Index Number: 121.01-00
                                                          Person To Contact:
------------------------------                            -----------------------, ID No. ----------------
--------------------------                                Telephone Number:
------------------------------                            --------------------
                                                          Refer Reply To:
                                                          CC:ITA:B04
                                                          PLR-103277-16
                                                          Date:
                                                          April 11, 2016

Legend

Taxpayers = ------------------------------
TIN: -------------------------------------
Residence 1 = -------------------------------------------------------------
Date 1 = ------------------------
Date 2 = -------------------
Date 3 = -------------------

Dear ---------------------:

This letter responds to your request for a ruling under § 121(c) of the Internal Revenue
Code. Specifically, you have requested that the gain on the sale of Residence 1 may
be excluded under the reduced maximum exclusion in § 121(c).

Taxpayers were married and had one child (a daughter) when they purchased
Residence 1 on Date 1. Residence 1, a condominium, had two small bedrooms and
two baths. The child’s bedroom also served as the Husband’s home office as well as a
guest room. After the purchase of Residence 1, Wife became pregnant and gave birth
to another child (a son). On Date 2, Taxpayers moved out of Residence 1, and on Date
3, Taxpayers sold Residence 1.

                                           Law and Analysis

Section 121(a) provides that gain from the sale or exchange of property is not included
in gross income if, during the 5-year period ending on the date of the sale or exchange,
the taxpayer has owned and used the property as the taxpayer’s principal residence for
periods aggregating two years or more.

Section 121(b)(1) provides the general rule for the maximum exclusion of gain. Section
121(b)(3) provides that subsection (a) shall not apply to any sale if, during the 2-year
period ending on the date of the sale, there was any other sale or exchange by the
taxpayer to which subsection (a) applied.
PLR-103277-16                                2

Section 121(c) provides for a reduced maximum exclusion when a taxpayer fails to
satisfy the ownership and use requirements of subsection (a) if the primary reason for
the sale is the occurrence of unforeseen circumstances.

The reduced maximum exclusion is computed by multiplying the applicable maximum
exclusion by a fraction. The numerator of the fraction is the shortest of the following
periods: (1) the period of time that the taxpayer owned the property during the 5-year
period ending on the date of the sale; (2) the period of time that the taxpayer used the
property as the taxpayer’s principal residence during the 5-year period ending on the
date of the sale; or (3) the period of time between the date of a prior sale or exchange of
property for which the taxpayer excluded gain under section 121 and the date of the
current sale. The numerator of the fraction may be expressed in days or months. The
denominator of the fraction is 730 days or 24 months (depending on the measure of
time used in the numerator).

Section 1.121-3(b) of the Income Tax Regulations provides that all the facts and
circumstances of a sale will determine whether the primary reason for the sale is the
occurrence of unforeseen circumstances. Factors that may be relevant in determining
the primary reason for a sale include the following: (1) the suitability of the property as
the taxpayer’s residence materially changes; (2) the circumstances giving rise to the
sale are not reasonably foreseeable when the taxpayer begins using the property as the
taxpayer’s principal residence; and (3) the circumstances giving rise to the sale occur
during the period of the taxpayer’s ownership and use of the property as the taxpayer’s
principal residence.

Section 1.121-3(e)(1) provides that a sale is by reason of unforeseen circumstances if
the primary reason for the sale is the occurrence of an event that the taxpayer could not
reasonably have anticipated before purchasing and occupying the residence. Section
1.121-3(e)(3) states that the Commissioner may issue rulings addressed to specific
taxpayers identifying events or situations as unforeseen circumstances with regard to
those taxpayers.

In the present case, based on the facts, representations, and the relevant law, we
conclude that the occurrence of unforeseen circumstances was the primary reason for
the sale and that the suitability of Residence 1 as the Taxpayers’ principal residence
materially changed. Accordingly, the gain on the sale of Residence 1, which Taxpayers
owned and used as a principal residence for less than two of the preceding five years,
may be excluded under the reduced maximum exclusion of gain in § 121(c).

                                         Caveats

Except as expressly provided, we express no opinion concerning the tax consequences
of any aspect of any transaction or item discussed or referenced in this letter.
PLR-103277-16                                 3

This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

A copy of this letter ruling must be attached to any income tax return to which it is
relevant. Alternatively, if taxpayers file a return electronically, taxpayers may attach a
statement to the return that provides the date and control number of the letter ruling.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayers and accompanied by a penalty of perjury statement
executed by the taxpayers. While this office has not verified any of the material
submitted in support of the request for a ruling, it is subject to verification on
examination.

                                       Sincerely,



                                       Donna Welsh
                                       Senior Technician Reviewer
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)




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