Tax 4-3 Identify the rules related to the Section 121 exclusion (Sale of Residence)

Question 1

Sale of a Principal Residence

When a taxpayer sells his or her principal residence, the gain, or a portion of the gain, from the sale may be excluded under Section ____

(4-3, 23)

Answer 1

121

Question 2

Sale of a Principal Residence

If the taxpayer sells the principal residence at a loss, there is no ____ for the loss.

(4-3, 23)

Answer 2

deduction

Question 3

Sale of a Principal Residence

The recognized (taxable) gain, if any, is reported on Form 1040, Schedule _, Capital Gains and Losses.

A
B
C
D

(4-3, 23)

Answer 3

D

Question 4

Sale of a Principal Residence

A principal residence may be a house, yacht, houseboat, house trailer, condominium, or a cooperative apartment or housing corporation in which the taxpayer owns stock and actually lives. If a
taxpayer has more than one residence…

(4-3, 23)

Answer 4

the one in which he or she resides for a majority of the time is considered to be the principal residence, unless the taxpayer can show otherwise.

Question 5

Sale of a Principal Residence

Under Section 121, realized gains on the sale of a principal residence may be excluded—up to $______ for married couples filing jointly or up to $_____ for single taxpayers.

(4-3, 23)

Answer 5

$500,000, $250,000

Question 6

Sale of a Principal Residence

For a single taxpayer to exclude the gain, two requirements must be met. They are:

(4-3, 24)

Answer 6

First, the taxpayer must meet the ownership and use test. The residence must have been owned and used as the principal residence for two of the past five years.

Second, the taxpayer must not have used the Section 121 exclusion within the past two years.

Question 7

Sale of a Principal Residence

In order for a married couple to exclude up to the full $500,000, the spouses must file a _____ return.

(4-3, 24)

Answer 7

joint

Question 8

Sale of a Principal Residence

In order for a married couple to exclude up to the full $500,000, the spouses must file a joint return, _____ of the spouses must have owned the home for at least two of the previous five years before the sale

one or both

(4-3, 24)

Answer 8

one

Question 9

Sale of a Principal Residence

In order for a married couple to exclude up to the full $500,000, the spouses must file a joint return, and _____ of the spouses must have used the home as a principal residence for at least two of the previous five years before the sale.

one or both

(4-3, 24)

Answer 9

both

In other words, ownership, but not use, of the residence may be attributed between spouses. Also, neither spouse can be ineligible for the full exclusion due to the once-every-two-year limit. If one spouse is unable to use the exclusion, the other spouse may still exclude up to $250,000 of gain.

Question 10

Sale of a Principal Residence

Example. W has owned a home that she has occupied as a principal residence for several years. On July 1, 2015, she marries H. H immediately moves into the home and they occupy it as a principal residence until August 1, 2017. H and W file a joint return for 2017. They may exclude up to…

(4-3, 24)

Answer 10

$500,000 on the sale of the residence. Although H had no ownership interest in the residence, they qualify for the full exclusion because one of the spouses (W) owned the residence for at least two of the five years prior to the sale, and they both used the residence for at least two of the five years prior to the sale.

Question 11

Sale of a Principal Residence

Example. During 2015, married taxpayers H and W each sell a residence that was separately owned and used as a principal residence by each before their marriage. Both spouses meet the ownership and use tests for his or her respective residence. Neither spouse meets the use requirement for the other spouse’s residence. H and W file a joint return for the year of the sales. The gain realized from the sale of H’s residence is $200,000. The gain realized from the sale of W’s residence is $300,000. Because the ownership and use requirements are met for each residence by each respective spouse, H and W are each eligible to exclude up to…

(4-3, 24)

Answer 11

$250,000 of gain from the sale of their individual residences. However, W may not use H’s unused exclusion to exclude gain in excess of her limitation amount. Therefore, H and W must recognize (include in income) $50,000 of the gain realized on the sale of W’s residence.

Question 12

Sale of a Principal Residence

A widow or widower may exclude up to $______ if the residence is sold not later than two years after their spouse’s death and the other requirements for the exclusion are met.

(4-3, 25)

Answer 12

$500,000

In other words, if a married couple would have qualified for a maximum exclusion of $500,000 immediately before the death of a spouse; gain up to $500,000 can be excluded on a sale of the residence by the unmarried surviving spouse within two years of the deceased spouse’s death. Note that the surviving spouse must be unmarried to qualify under this special
provision.

Question 13

Sale of a Principal Residence

Example. Married taxpayers H and W have owned and used their principal residence since 2009. On February 16, 2014, H dies. On February 1, 2016, W sells the residence and realizes a gain of $450,000. W files a return as a single taxpayer for 2016. How much can be excluded?

(4-3, 25)

Answer 13

All $450,000 of the gain from the sale of the residence may be excluded, because the sale took place within two years of H’s death.

Assume the same facts as the previous example, except that W does not sell the residence until March 1, 2016. Because W sold the residence more than two full years after H’s death, W may exclude only $250,000 of the gain.

Question 14

Sale of a Principal Residence

In determining whether a taxpayer has satisfied the two-year use requirement, occupancy of the residence is required. However, short temporary absences, such
as for vacation or other seasonal absence are counted as periods of use. Rental of the residence during these short periods of temporary absence is…

(4-3, 25)

Answer 14

still apparently treated as occupancy of the residence.

In general, these exclusions may not be used more than once within a two-year period.

Question 15

Sale of a Principal Residence

An exception to the once-every-two-year rule and the two-out-of-five-year rule is available if a taxpayer moves because of a new job, for health reasons, or due to other “unforeseen circumstances” as defined in the Regulations. Examples:

(4-3, 26)

Answer 15

the involuntary conversion of the residence,

natural or man-made disasters or acts of war or terrorism resulting in a casualty to the residence,

death of a qualified individual,

a qualified individual’s cessation of employment which makes the individual is eligible for unemployment compensation,

a change in employment or self-employment status of a qualified individual that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household,

a qualified individual’s divorce or legal separation under a decree of divorce or separate maintenance, and

multiple births resulting from the same pregnancy of a qualified individual.

Question 16

Sale of a Principal Residence

An exception to the once-every-two-year rule and the two-out-of-five-year rule is available if a taxpayer moves because of a new job, for health reasons, or due to other “unforeseen circumstances” as defined in the Regulations.

A qualified individual for this purpose is…

(4-3, 25)

Answer 16

the taxpayer, the taxpayer’s spouse, a co-owner of the residence or a person whose principal place of abode is in the same household as the taxpayer.

Question 17

Sale of a Principal Residence

An exception to the once-every-two-year rule and the two-out-of-five-year rule is available if a taxpayer moves because of a new job, for health reasons, or due to other “unforeseen circumstances” as defined in the Regulations.

In such cases, a partial exclusion—a pro rata exclusion—is available. For example, a single person living in his or her home for six months, who then moves to take a new job, can exclude up to…

(4-3, 25)

Answer 17

$62,500 of gain

$250,000
* 25%
= $62,500 of gain

6 months is 25% of 2 years

Question 18

Sale of a Principal Residence

On July 1, 2015, Eugene moves into a house that he owns and had rented to tenants since July 1, 2007. Eugene took depreciation deductions totaling $14,000 for the period that he rented the property. After using the residence as his principal residence for two full years, he sells the property on August 1, 2017. Eugene’s gain realized from the sale is $40,000. Only _____ may be eligible for exclusion.

(4-3, 27)

Answer 18

$40,000 gain realized
- $14,000 depreciation deductions
= $26,000 eligible for exclusion

Eugene must recognize $14,000 of the gain as unrecaptured Section 1250 gain.

Question 19

Sale of a Principal Residence

Last, for divorced or legally separated taxpayers, if _____ meets the two of-five year test and one spouse lives in the residence by court order, then each spouse may exclude up to $250,000.

one spouse or either spouse

(4-3, 28)

Answer 19

either spouse

Question 20

Sale of a Principal Residence

The amount of gain allocated to periods of nonqualified use is the amount of gain multiplied by a fraction, the numerator of which is the aggregate periods of nonqualified use during the period the property was owned by the taxpayer and the denominator of which is the _____.

(4-3, 29)

Answer 20

period the taxpayer owned the property

Question 21

Sale of a Principal Residence

John buys a mountain cabin on January 1, 2007, for $400,000, and uses it as his vacation property until January 1, 2013. On January 1, 2013, John converts the property to his principal residence. On January 1, 2016, he moves out and sells the property for $700,000. In calculating the portion of the gain allocable to nonqualified use, the numerator of the fraction is 4 (years of nonqualified use after 2008), and the denominator is 9 (years of ownership). How much of the gain is excluded?

(4-3, 29)

Answer 21

4 Years of Non-qualified use
/ 9 Years of ownership
= 44% Ratio of Non-qualified use

$700,000 Sale Price 
- $400,000 Basis
= $300,000 Profit
* 44% Ratio of Non-qualified use
= $133,333 Recognized as gain 

$166,667 Gain eligible for Exclusion

Note that in this example, the years of use prior to 2009 are not taken into account in the numerator. Nonqualified use refers to any period after 2008 during which the property is not used as the principal residence of the taxpayer, spouse, or former spouse.

Question 22

Sale of a Principal Residence

Assume that an individual buys a principal residence on January 1, 2009, for $400,000, moves out on January 1, 2019, and on December 1, 2021, sells the property for $600,000. How much of the gain is excluded?

(4-3, 29)

Answer 22

The entire $200,000 gain is excluded from gross income because periods after the last qualified use do not constitute nonqualified use.

Question 23

Sale of a Principal Residence

Assume that Frank buys a property on January 1, 2011, for $400,000, and uses it as rental property for two years, claiming $20,000 of depreciation deductions. The depreciation deductions reduce his basis to $380,000. On January 1, 2013, Frank converts the property to his principal residence. On January 1, 2016, Frank moves out, and sells the property for $700,000. How much of the gain is excluded?

(4-3, 29)

Answer 23

2 Years of non-qualified use
/ 5 Years of ownership
= 40% Ratio of non-qualified use

  $700,000 Sale Price 
- $400,000 Basis
= $300,000 Profit
* 40% Ratio of non-qualified use
= $120,000 Recognized as gain 

$180,000 Gain eligible for exclusion

Since the remaining gain of $180,000 is less than the maximum gain of $250,000 that may be excluded, the remaining gain of $180,000 is excluded.

Question 24

Sale of a Principal Residence

Vikki buys a lakeside cabin on January 1, 2013, for $400,000, and uses it as her vacation property until January 1, 2015. On January 1, 2015, she converts the property to her principal residence. On January 1, 2016, Vikki moves out and sells the property for $700,000 when her employer transfers her to a location in a different part of the country. How much of the gain is excluded?

(4-3, 30)

Answer 24

2 Years of non-qualified use
/ 3 Years of ownership
= 67% Ratio of non-qualified use

  $700,000 Sale Price 
- $400,000 Basis
= $300,000 Profit
* 66.67%	Ratio of non-qualified use
= $200,000 Recognized as gain 

$100,000 Gain eligible for exclusion

However, Vikki did not meet the two-years-of-use requirement due to a job transfer. Thus, she is eligible for a partial exclusion. She used the property as a principal residence for one of the required two years, and is eligible for a maximum exclusion of $125,000 (50% of the maximum exclusion for a single taxpayer).

Because the $100,000 of gain is less than the partial exclusion of $125,000, she may exclude the $100,000 of gain.

Question 25

Sale of a Principal Residence

The nonqualified use provision applies only where the taxpayer used the residence for nonqualified purposes and then converted the property to a principal residence. The opposite is not true. If the taxpayer used the residence as a principal residence, and then converts the property to a nonqualified use, the
taxpayer may potentially qualify for a full Section 121 exclusion. If the taxpayer uses a residence as a principal residence for _____ full years, the property may be converted to a nonqualified use for up to three years, and still qualify for a full Section 121 exclusion.

one

two

three

four

five

(4-3, 31)

Answer 25

two

The property may even be rented during that three-year period.

Question 26

Sale of a Principal Residence

Katie, a single taxpayer, purchases and immediately moves into her principal residence on January 1, 2012. The basis of the residence is $350,000. She uses the residence as her principal residence through December 31, 2013. On January 1, 2014, she converts the property to a rental property. She sells the residence for $600,000 on December 31, 2016, after claiming $37,650 in depreciation deductions. Thus, the total gain on the sale is $287,650. How much of the gain is excluded?

(4-3, 31)

Answer 26

The first $37,650 is unrecaptured Section 1250 income, typically taxed at 25%.

The remaining $250,000 gain may be fully excluded under Section 121.

The property was owned and used as a principal residence for at least two years during the five year period ending on the date of sale. The nonqualified use provision is not applicable as the nonqualified use (the rental use) occurred after the last date the property was used as the principal residence of the taxpayer.

Question 27

Sale of a Principal Residence

Principal residence requirement. Note that the exclusion provision relates to a taxpayer’s principal residence. The regulations to Section 121 provide guidance on the definition of a principal residence. If a taxpayer uses more than one property as a residence, whether the taxpayer uses a particular property as the
principal residence depends upon all the facts and circumstances. If a taxpayer alternates between two properties, using each as a residence for successive
periods of time, the property that the taxpayer uses a majority of the time during the year ordinarily will be considered the taxpayer’s principal residence. In
addition to the taxpayer’s use of the property, relevant factors in determining a taxpayer’s principal residence, include, but are not limited to, the following:

(4-3, 32)

Answer 27

The taxpayer’s place of employment

The principal place of abode of the taxpayer’s family members

The address listed on the taxpayer’s federal and state tax returns, driver’s license, automobile registration, and voter registration card

The taxpayer’s mailing address for bills and correspondence

The location of the taxpayer’s banks

The location of religious organizations and recreational clubs with which the taxpayer is affiliated

Question 28

Sale of a Principal Residence

Anthony owns two residences, one in New York and one in Florida. From 2011 through 2016, he lives in the New York residence for seven months and the Florida residence for five months of each year. Where is the principal residence? Where would the gain exclusion be?

(4-3, 32)

Answer 28

In the absence of facts and circumstances indicating otherwise, the New York residence is Anthony’s principal residence. He would be eligible for the exclusion of gain from the sale or exchange of the New York residence, but not the Florida residence.

Question 29

Sale of a Principal Residence

Becky owns two residences, one in Virginia and one in Maine. During 2013 and 2014, she lives in the Virginia residence. During 2015 and 2016, she lives in the Maine residence. During 2017, she lives in the Virginia
residence. Where is the principal residence? Where would the gain exclusion be?

(4-3, 33)

Answer 29

Becky’s principal residence during 2013, 2014, and 2017 is the Virginia residence.

Becky’s principal residence during 2015 and 2016 is the Maine residence.

She would be eligible for the exclusion of gain from the sale or exchange of either residence (but not both) during 2017.

Question 30

Module Review

18. David and Kristen are married taxpayers filing jointly. They lived in their principal residence for six months, and sold the residence because Kristen was transferred to a job out-of-state. They have a realized gain of $145,000 on the residence. They have not used the Section 121 exclusion in the past. What is the maximum Section 121 exclusion, if any, that they may claim?
    a. $0
    b. $36,250
    c. $125,000
    d. $500,000

(LO 4-3)

Answer 30

c. $125,000

The partial exclusion is six months of ownership and use divided by the required 24 month ownership and use period. Thus 25% of $500,000 = $125,000.

a. is incorrect because “If the taxpayer fails to meet the two-out-of-five-year ownership and use requirement due to health, job, or unforeseen circumstances, the taxpayer may utilize a partial Section 121 exclusion.”
b. is incorrect because “The partial exclusion is based on a percentage of the maximum exclusion, not on a percentage of the gain realized.”
d. is incorrect because “The taxpayer qualifies for only a partial exclusion if he or she did not meet the two-out-of-five-year ownership and use requirement due to health, job, or unforeseen circumstances.”

Question 31

Module Review

19. For a married couple filing jointly to claim a full $500,000 Section 121 exclusion,
    a. at least one spouse must have owned, and both spouses must have lived in, the residence for at least two out of the previous five years.
    b. both spouses must have owned, and both spouses must have lived in, the residence for at least two out of the previous five years.
    c. at least one spouse must have owned, and at least one spouse must have lived in, the residence for at least two out of the previous five years.

(LO 4-3)

Answer 31

a. at least one spouse must have owned, and both spouses must have lived in, the residence for at least two out of the previous five years.

Ownership, but not use, may be attributed between spouses. In other words, at least one spouse must have owned, but both spouses must have lived in the residence for at least two out of the previous five years.

Question 32

Module Review

21. Which one of the following statements is correct regarding the Section 121 exclusion?
    a. The maximum exclusion for a married couple filing jointly is $250,000.
    b. A taxpayer must be age 55 or older to qualify for the exclusion.
    c. In order to qualify for a full exclusion, the exclusion may not be used more than once in a three-year period.
    d. The exclusion may not be used if the residence was acquired in a like-kind exchange within the last five years.

(LO 4-3)

Answer 32

d. The exclusion may not be used if the residence was acquired in a like-kind exchange within the last five years.

The Section 121 exclusion may not be used if the residence was acquired in a like-kind exchange within the last five years.

a. is incorrect because “The maximum exclusion for a single taxpayer is $250,000. The maximum exclusion for a married couple filing jointly is $500,000.”
b. is incorrect because “There is no age limitation for the Section 121 exclusion.”
c. is incorrect because “In order to qualify for a full exclusion, the exclusion may not be used more than once in a two-year period.”

Question 33

Module Review

29. Which one of the following is not treated as an unforeseen circumstance for purposes of allowing a partial exclusion under Section 121?

death of a qualifying individual

loss of job by a qualified individual

divorce of a qualifying individual

unruly and disruptive neighbors that seriously irritate a qualifying individual

(LO 4-3)

Answer 33

unruly and disruptive neighbors that seriously irritate a qualifying individual

Selling the residence due to unruly and disruptive neighbors is not treated as an unforeseen circumstance. Death, loss (or serious downgrade) of job, and divorce of a qualifying individual are all treated as an unforeseen circumstance, allowing a partial exclusion under Section 121.