Is the Sale of Your Principal Residence Due to Unforeseen Circumstances?
While the quick appreciation is the good news, the bad news may be that by flipping your principal residence quickly, you may be ineligible to exclude the appreciation from income tax.
Most taxpayers know that married couples filing a joint income tax return can permanently exclude up to $500,000 of gain generated from the sale of their principal residence. Taxpayers not filing jointly can exclude $250,000 of gain. However, many taxpayers do not know that in order to qualify for this exclusion, the property must be owned and used as your principal residence for 2 out of 5 years. In addition, the exclusion does not apply if you used the exclusion within 2-years of the date of the current sale. For example, if you sold your principal residence in June 2015, used all or part of the exclusion, and then sold your new principal residence in December 2016, an additional exclusion will not be available because you used all or a portion of it within the two years from the date you sold the new principal residence.
The Treasury recognizes that taxpayers may be forced to sell their principal residence within a 2 year period of time due to change of employment, health or other unforeseen circumstances. In this case, the exclusion can be used again but the amount has to be prorated by dividing the number of months between the date of the prior sale over 24 months. The Treasury has issued regulations to attempt to define “unforeseen circumstances”. Unforeseen circumstances include:
- Involuntary conversion of the residence.
- Natural or man-made disasters or acts of war or terrorism resulting in a casualty to the residence
- The cessation of employment which leads to the eligibility of unemployment compensation
- A change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses
- Divorce or legal separation
- Multiple births resulting from the same pregnancy.
- Other unforeseen circumstances that the Treasury may designate through general publications or by private rulings.
For those in the situation of selling their principal residence within the two year period and who do not qualify for any of the specific items mentioned above, they hope that their circumstances can qualify as an “unforeseen circumstance” under # 8 above. If they can demonstrate that they meet “unforeseen circumstances” then at least they will qualify for a portion of the exclusion.
The Treasury recently issued a private letter ruling that demonstrates how they will view “unforeseen circumstances”. The taxpayer in the letter ruling sold their current principal residence within 2 years of using the exclusion for a previous principal residence. The current residence had two bedrooms, one of which was used as both a child’s room and the husband’s home office. After the purchase, the wife became pregnant and gave birth to a second child. Due to the second child, the husband had to give up sharing the second bedroom as his home office. The Treasury held that the birth of the second child was an unforeseen circumstance that materially changed the suitability of the principal residence. Accordingly, Taxpayers were allowed to use a portion of the exclusion against the gain on the sale the current principal residence.
While this ruling is applicable only to the taxpayers who requested it, the ruling does show the Treasury’s reasoning for granting use of the exclusion. Based upon this ruling, the Treasury seems to be applying the definition of “unforeseen circumstances” very liberally.
It may be beneficial for taxpayers selling their principal residence with the 2 year period to apply for a private ruling to determine if their situation falls under the definition of “unforeseen circumstances”. If you are interested in seeing if this applies to your specific circumstances, please reach out to your tax advisor or a member of Withum’s Private Client Services Team at [email protected].
Ask Our Experts
|Robert E. Demmett, CPA, MS, Partner
T (212) 829 3210
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.