Category: Nontaxable Exchanges; Individuals; Real Estate
Subject: Residence, Sale of
Title: Divorced Couple--Issues Related to Gain on Sale
IRC Sections: 1034, 121
Filename: 1126.html
Date Produced: 2/97

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Background
Taxpayer (TP) vacated the marital residence (owned as community property) incident to a separation and divorce. The other spouse remained in the residence. The house will be sold about 18 months to two years after TP's departure. TP will be more than 55 years of age at the time of sale. Neither he nor his spouse (the former spouse and/or any new spouse at the time of the sale) have made such an election in the past.

I assume the home was not listed for sale immediately after TP's departure and the sale has simply been delayed by the conditions of the local real estate market.

Issues
1. Can TP defer his portion of the gain under Section 1034 by reinvesting the proceeds within the applicable time period?

2. Can TP exclude some or all of his portion of the gain under Section 121?

Answers
1. The rollover provisions of Section 1034 are not available to this taxpayer.

2. Assuming the house is sold within two years of TP's departure, it appears that an election under Section 121 is available; however, certain timing issues are critical and could alter this conclusion. See the discussion below.

Discussion: Issue One
Generally, in order to defer gain on the sale of a principal residence under Section 1034, the house in question must be the taxpayers principal residence at the time of sale. IRC Section 1034. Whether a particular house is the taxpayer's principal residence at a given time is to be determined on a facts and circumstances basis. Reg. Section 1. 1034-1(c)(3).

Generally speaking, a home not in the taxpayer's possession at the time of sale cannot be treated as the taxpayer's principal residence. There are, however, a number of cases in which the courts have ruled favorably where a taxpayer vacated his old residence, typically due to a job change, and was unable to sell the old residence for a period of time due to poor conditions in the local real estate market. See, for example, Claipham v. Comr., 63 TC 505 (1975), acq., 1979-2 CB 1. This is the so-called "market exigencies" exception.

The courts have consistently declined to apply the market exigencies exception in the case of divorce. The principal cases are Young v. Comr., TC Memo 1985-127; and Perry v. Comr., 67 TCM 3035 (1994), aff'd 96-2 USTC ¶50,405 (9th Cir. 1996). The Young court stated that the market exigencies cases had unusual or exceptional facts and circumstances over which the taxpayer had no control. A divorce, the court held, is not the type of external, objective, circumstance that allows a taxpayer not in possession of a home to be deemed a resident therein for purposes of Section 1034(a). 49 TCM at 1003-4.

Discussion: Issue Two
Section 121 allows an election to exclude up to $125,000 of gain from the sale of a principal residence. In order to qualify, the taxpayer must be 55 years of age or older prior to the date of sale and have occupied the home as a principal residence for three out of the five years prior to the sale. Temporary absences such as vacations and such do not reduce the amount of time the taxpayer has occupied the home as a principal residence; however, longer absences are not ignored for this purpose.

Given that the sale is expected to occur within two years of TP's departure from the residence, it appears that the three-out-of-five-year standard will be met. Note carefully, however, that there is little time to spare. Since the sale is expected within two years of departure, that leaves only the bare minimum three years of occupancy. Any absence during the period prior to TP's departure from the home could adversely affect the conclusion. I suggest carefully reviewing TP's time in the residence prior to his departure. Were there any absences from the home other than for things like vacations and brief business trips? For example, sometimes divorcing parties have a period of trial separation prior to the final decision to split up. Anything of that sort could change the outcome of this analysis entirely.
Note that if TP is married at the time of the sale (i.e., TP's divorce is not yet final or TP has remarried by that time), TP's spouse must consent to the election even if TP and spouse do not file a joint return.

As you know, the election under Section 121 can be made only once in a lifetime. Also, take note that exclusion of gain under Section requires an affirmative election, generally on Form 2119.