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Section 121 Exclusion: For sales of a personal residence after 5/6/97, a homeowner may exclude from income up to $250,000 of gain and a married couple may exclude up to $500,000 of gain realized on the sale. The deferral of gain rules under section 1034 and the age 55 lifetime exclusion of $125,000 have been repealed except for special transition rules.

Individuals: Qualify to exclude up to $250,000 under the following conditions:

• Ownership and Use: Individual must have owned and used the home as a principal residence for at least two out of the five years prior to the sale (the two years do not have to be consecutive).
  
• Frequency Limitation: Exclusion applies to only one sale every two years.

Married Couples: Qualify to exclude up to $500,000 under the following conditions:

• Joint Return: The married couple must file a joint return.
  
• Ownership: Either or both spouses(s) must have owned the residence for at least two out of the five years prior to the sale.
  
• Use: Both spouses must have used the residence as their principal residence for at least two out of the five years prior to the sale.
  
• Frequency Limitation: Neither spouse may have sold a home more than once every two years ( sales before May 7, 1997 are not taken into account).

Use and Frequency Tests Not Met by Both Spouses: For a married couple to qualify for the full $500,000 exclusion, either spouse may meet the ownership test, but both spouses must meet the use and frequency test. If either spouse does not meet the use and frequency test, the allowable exclusion is limited to the sum of the amounts that each spouse would be qualified to exclude if they had not been married Each spouse is treated as owning the property for the period of time that either spouse owned the property.

Ownership: The ownership test generally requires that the taxpayer own the residence directly, not through an entity.

• Limited Partnership: In a private letter ruling, the IRS determined a personal residence held by a limited partnership would not qualify for the exclusion.
  
• Grantor Trust: A taxpayer is considered to be the owner of a residence held in a grantor trust, since the property held in a grantor trust is considered owned by the grantor.
  
• Irrevocable Trust: The IRS has denied the full exclusion to a taxpayer that held a personal residence in an irrevocable trust.

Reduced Exclusion Rules: Taxpayers who do not meet the two-year ownership and use test of Section 121, or use the Section 121 exclusion more than once in a two-year period, may qualify for a reduced exclusion.

• A home owned on 8/5/97, and sold for any reason before 8/5/99.
  
• A home sold due to job relocation, health reasons, or other "unforeseen circumstances."

Business Use of Home: When a personal residence is also used for business (office in home, rental duplex, etc.), the home must be divided into two assets. The portion of gain attributable to the business use is taxable as a sale of a business asset. The gain attributable to the personal use may qualify for the Section 121 exclusion.

The "Use" Test includes Rental Use: The IRS has proposed regulations that say qualifying the "use" of a property as a principal residence may occur while the taxpayer does not own the property, rather rents it and lives in it for two years out of five preceding sale; at some time purchases it and owns the townhouse two out of the five years preceding the sale.

Two Homes: The IRS has issued proposed regulations that say when a taxpayer alternates between two homes; the home that is used for a majority of the time during the year will ordinarily be considered the principal residence.

Temporary Absences: For purposes of the two-year use requirement, the taxpayer must actually occupy the residence. However, short temporary absences, such as for vacation or other seasonal absences are counted as periods of use (even if the residence is rented out during the taxpayer's absence).

    This information has been provided as a service and the Taxpayer is strongly advised to seek counsel from their own independent tax advisors, tax attorneys, and/or CPA, as to their own specific situation regarding the tax consequences and tax implications.

    The information on this page is brought to you courtesy of the California Department of Real Estate.

    For more information or to discuss your requirements call me on 949-632-6363 (Cell). You may send me a fax on 949-675-2156 or email me at sally@sallymartinrealtor.com.