Category: Real Estate; Individuals, Nontaxable Exchanges
Subject: Residence, Sale of
Title: Section 121 Exclusion, Partial Business Use
IRC Sections: 121, 1034, 280A(c)(6)
Filename: 1285.html
Date Produced: 10/95

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Background
TP has rented a portion of his residence to his S corporation for a number of years. TP is an employee of the S corporation. The business conducted by the S corporation will be sold on or about October 31, 1995. The residence will be sold in January, 1996. TP will be at least 55 years of age at the time the residence is sold.

Issue
Does the exclusion of gain under Section 121 apply to the entire residence or simply the non-rental portion?

Answer
Section 121 applies only to the non-rental portion.

Discussion
Section 121 allows eligible taxpayers to exclude up to $125,000 of gain from sale of a principal residence. In general, at the time of sale, the taxpayer must be at least 55 years of age and have owned and used the home as his principal residence for three of the previous five years.

Section 121(d)(5) and Regulation Section 1.121-5(e) provide that if a taxpayer meets the ownership and use requirements with respect to only a portion of the home, then the exclusion provisions of Section 121 still apply, but only to the portion of the home with respect to which the ownership and use requirements are met.

The regulations give the example of an attorney who used a portion of his home for business purposes for more than two of the five years preceding the sale. The business portion of the home is not eligible for Section 121 treatment.

Revenue Ruling 82-26, 1982-1 CB 114, addresses for purposes of the rollover provisions of Section 1034 the circumstance in which a portion of the taxpayer's residence is used for business. In one scenario, tax deductions with respect to the taxpayer's use of the home were allowable. In the other scenario, deductions were not allowable under Section 280A. The ruling holds that for purposes of Section 1034, business use not allowable under Section 280A does not count as non-personal-residence-use for purposes of Section 1034.

The situation at hand is somewhat analogous to the non-allowable deduction circumstance of Rev. Rul. 82-26. Section 280A(c)(6) provides that the rules which allow either a home office or a home rental deduction do not apply if the taxpayer rents his home to his employer. It appears that Section 280A(c)(6) should apply to this case. Does that mean that Section 121 applies to the rental portion of TP's residence through extension of the principle of Rev. Rul. 82-26? I think the answer is no.

Section 121 has an additional statutory requirement that Section 1034 does not: namely, the three-out-of-five year rule. It seems clear to me that however the deductions with respect to TP's rental use are characterized by Section 280A, TP plainly did not use that portion of his home for personal residence purposes. Accordingly, Section 121 should not apply to the rental portion of the residence notwithstanding Rev. Rul. 82-26.

There was an opportunity for Congress to carve out an exception under Section 121(d)(5) for business use that falls short of Section 280A. Treasury also had the opportunity to do so under Regulation Section 1.121-5(e). Finally, IRS had the opportunity to broaden the scope of Rev. Rul. 81-26 to explicitly include Section 121. The overlap of Sections 121 and 1034 is not obscure issue. Given the additional statutory requirement of Section 121, I feel that Congress, Treasury, and IRS intentionally did not carve out a Section 280A exception under Section 121(d)(5).