IRS clarifies tax laws on sale of principal residence
By Gordon Howard
Special to The Desert Sun
May 1, 2003

Back in 1997, new laws were passed regarding the ability to exclude the gain on the sale of your principal residence.

The law is very generous allowing the exclusion of up to a $250,000 gain for a single individual and a $500,000 gain for a married couple filing jointly and it can be claimed repeatedly once every two years.

This new liberal exclusion applies to taxpayers who used their home as a principal residence for two out of the last five years prior to the sale.

Recently, the Internal Revenue Service issued a series of regulations to clarify some of the questions that arose regarding the time of residency requirement.

There is a special rule that if you don’t live in the house for the full two years, it is possible to get a limited exclusion based on the percentage of the two years that you did live there.

This means if you lived in the house for one year, you may be entitled to half the exclusion that you otherwise would be entitled to.

For instance, a married couple living in the house for one year instead of two years could be entitled to a $250,000 gain exclusion -- half of the full two-year $500,000 amount.

There are exceptions that will allow this exclusion if you moved because of “unforeseen circumstances.”

These include death, divorce, or legal separation, becoming eligible for unemployment compensation, a change in employment that leaves you unable to pay the mortgage or living expenses, multiple births resulting from the same pregnancy, damages to the residence resulting from a natural or man-made disaster, or an act of war or terrorism with condemnation, seizure, or other involuntary conversion of property.

As you can see, these situations leave a lot of wiggle room for you to exclude at least part of the gain even if you do not meet the two-year requirement.

Interestingly, these new regulations were just promulgated and they are retroactive to 1997 when the rule was first put into play.

This means that if any of the above circumstances apply, it may be possible for you to file an amended return and claim this exclusion.

Generally, you can file an amended return up to three years from the original due date of the tax return.

In addition to the above exceptions, there is also an exclusion allowed when the sale is made because of health reasons related to a disease, illness or injury of the taxpayer.

If your physician recommends a change in residence for health reasons, that will also qualify. Health reasons may even include the health of certain close relatives, so sales related to caring for sick family members can also qualify.