CCH-EXP, CCH Federal Tax Service §F:8.81[1], Amount and Type of Gain Excludable
Amount and Type of Gain Excludable

The maximum amount of gain that may be excluded each time this provision is used generally is $250,000.16  However, it is $500,000 for most married taxpayers filing jointly.17  See §F:8.81[2].

16 Code Sec. 121(b)(1).

17 Code Sec. 121(b)(2).

COMMENT:  One stated rationale for this expanded principal residence gain exclusion has been the burdensome recordkeeping taxpayers faced for many years in tracking their residential bases for both the prior law two-year rollover (see §F:8.100) and the prior law age 55 $125,000 exclusion (see §F:8.120). In fact, many sales where the total consideration does not exceed the maximum exclusion are not subject to the normal real estate information return requirement. See §F:8.85. However, there could be many instances in which basis recordkeeping is useful, even essential, such as: 

l computing the gain when the sale price exceeds the maximum exclusion, or the taxpayer is entitled only to a partial exclusion; 

l conversion of part or all of the property to business use, and subsequent depreciation and like-kind exchanges; 

l gifts; 

l divorce; and 

l involuntary conversions.

A partial exclusion of gain may be available even if a taxpayer does not meet the ownership and use requirements (see §F:8.83)18  or has already used the exclusion within the two years ending on the date of the sale or exchange.19  An otherwise nonqualifying sale or exchange generally must occur by reason of a change in place of employment, health or, to the extent to be prescribed by regulations, other unforeseen circumstances.20  However, this prerequisite for using the partial exclusion is not required when the taxpayer holds the property on August 5, 1997, and sells or exchanges it within the two-year period beginning on that date.21  This partial exclusion is limited to the ratio of the maximum exclusion of $250,000 ($500,000 if married filing a joint return)22  to the ratio borne to two years by the shorter of:

18 See Code Sec. 121(a).

19 Code Sec. 121(c)(2)(B); see Code Sec. 121(b)(3).

20 Code Sec. 121(c)(2).

21 P.L. 105-34, 105th Cong., 1st Sess., §312(d)(3) (Aug 5, 1997).

22 Code Sec. 121(c)(1)(A).

l the aggregate periods that the ownership and use requirements were met during the five years before the sale or exchange;23  or

23 Code Sec. 121(c)(1)(B).

l the period between the most recent use of this exclusion and the sale or exchange for which the exclusion is to be used again.24  

24 Id.

COMMENT: An otherwise qualifying taxpayer who fails to satisfy the two-year ownership and use requirements is able to exclude an amount equal to the fraction of the $250,000 ($500,000 if married filing a joint return), not the fraction of the realized gain which is equal to the fraction of the two years that the ownership and use requirements are met.

EXAMPLE:  An unmarried taxpayer who owns and uses a principal residence for one year then sells at a realized gain of $500,000 may exclude $125,000 of gain (one half of $250,000) not $250,000 of gain (one half of the realized gain). Similarly, an unmarried taxpayer who owns and uses a principal residence for one year then sells at a realized gain of $50,000 may exclude the entire $50,000 of gain since it is less than one half of $250,000. The exclusion is not limited to $25,000 (one half of the $50,000 realized gain).

The exclusion of gain from the sale or exchange of a principal residence does not apply to:

l gain attributable to depreciation adjustments on the property for depreciation recapture, which is essentially accelerated and short-term depreciation (see §G:21.66)25  attributable to periods after May 6, 1997;26  

25 See Code Sec. 1250(b)(3).

26 Code Sec. 121(d)(6).

l any partial or future interest in the fee simple to the property, other than a remainder interest to which the taxpayer elects to apply the exclusion,27  except that even gain on a remainder interest does not qualify for the exclusion if the sale is to any person related to the taxpayer under either the general related party rules28  or the partnership related party rules;29  

27 Code Sec. 121(d)(8)(A).

28 See Code Sec. 267(b).

29 See Code Sec. 707(b).

l any sale or exchange by an expatriate (see §M:7.20);30  or 

30 Code Sec. 121(e); see Code Sec. 877(a)(1).

l any sale or exchange for which the taxpayer elects not to have this exclusion apply.31  

31 Code Sec. 121(f).

If the principal residence exclusion applies to a reacquisition of real property when the exclusion was already applied to the original sale, and the taxpayer sells the property again within one year of the reacquisition, then under regulations to be prescribed by the Service the usual rules for reacquisitions of property do not apply regarding gain,32  basis,33  and debt treated as worthless before the reacquisition.34  In that case, the exclusion is applied as though the resale was part of the original sale.35  See §E:12.200 and §F:3.83 for discussion of the reacquisition of real property.

32 See Code Sec. 1038(b).

33 See Code Sec. 1038(c).

34 See Code Sec. 1038(e).

35 Code Sec. 1038(e).