Category: Nontaxable Exchanges; Real Estate
Subject: Principal Residence, Sale of
Title: Cost of Replacement Residence
IRC Sections: 1034
Filename: 1227.html
Date Produced: 05/95 Copyright 1998, The Tax Resource Group. All rights reserved. Telephone
800-578-3498. Internet: www.taxresourcegroup.com Issue
Does the cost of a replacement residence under Section 1034 include substantial
improvements to the residence after the purchase? Suppose the taxpayer sells
his principal residence for $475,000 and purchases a replacement residence
for $425,000. If the taxpayer subsequently invests another $50,000 in capitalizable
improvements within the two year replacement period, must the taxpayer recognize
any gain on the original sale? Answer
Assuming the taxpayer's transaction qualifies under Section 1034 in all
respects and the only question is the amount of reinvested proceeds, no
gain need be recognized in the factual scenario set forth above. The amount
deemed reinvested includes improvements properly charged to a capital account
made within the two year replacement period set forth in Section 1034(a). Discussion
Both the Code and Regulations under Section 1034 specifically sanction including
the cost of improvements in the cost of the replacement residence. See Section
1034(c)(2), Regs. Sections 1.1034-1(a), 1.1034-1(c)(2). Consider the specific
language of the Code. In determining the taxpayer's cost of purchasing a residence, there shall
be included only so much of his cost as is attributable to the acquisition,
construction, reconstruction, and improvements made which are properly
chargeable to capital account, during the period specified in subsection
(a). [Emphasis added.] Notice that the improvements must be properly chargeable to a capital
account. Presumably that means the improvements must be substantial and
increase the useful life of the home. Notice also that the improvements
must be made within the ordinary replacement period. The taxpayer does not
get an additional period after purchase of the replacement. The taxpayer
is only allowed to use what is left of the original replacement period which
is two years on either side of the sale of the old residence. Attached is an illustrative example excerpted from the Practitioner's
Publishing Company Tax Planning Guide for Individuals. | 
