Magazine article The CPA Journal

IRS Guidance on Home Sales

Magazine article The CPA Journal

IRS Guidance on Home Sales

Article excerpt

Applying the Sale-of-Residence Exclusion and the Like-Kind Exchange Deferral to the Same Transaction

IRS Revenue Procedure 2005-14 provides guidance on applying both IRC section 121, regarding the exclusion of gain on the disposition of a principal residence, and section 1031, regarding non-recognition of gain on a like-kind exchange, to the disposition of a single property. As home prices escalate, many taxpayers find themselves in a position to benefit from the simultaneous applications of both provisions. Fortunately, the rules are relatively straightforward.

1RS Guidance on Applying Both Provisions

section 4.02( 1 ) of Revenue Procedure 2005-14 provides that when both provisions apply, gain is excluded under section 121 before any gain deferral under section 1031. Under IRC section 121, the taxpayer may exclude up to $250,000 of gain ($500,000 on joint returns) on the sale or exchange of property if it was owned and used as the taxpayer's principal residence for at least two years out of the five-year period ending on the date of the disposition. Under IRC section 121(d)(6), however, gain that is attributable to depreciation deducted after May 6, 1997, is not eligible for the exclusion.

An additional restriction applies where property is partly used as a residence and partly held for productive use (business or investment), and the productive-use part of the property is not located in the same dwelling unit as the residence. In that situation, section 2.03 of Revenue Procedure 2005-14 provides that the gain attributable to the productive-use part of the property is not eligible for the exclusion unless it also passes the two-year-use test If the productive-use and residential portions of the property are separate but within the same dwelling unit, the gain attributable to the productive-use part of the property is eligible for the exclusion. To determine the amount of gain assigned to the productive-use and residential parts of the property, section 2.04 of Revenue Procedure 2005-14 provides that the taxpayer must allocate basis and amount realized using the same method used for assigning depreciation to the property. The 1RS considers square footage to be an appropriate basis for allocation.

On the residential part of the property, any gain in excess of the section 121 exclusion is taxable. On the productive-use part of the property, however, the gain in excess of the section 121 exclusion may be eligible for deferral under IRC section 1031. section 1031(a) provides that when productive-use property is exchanged solely for like-kind property, no gain or loss is recognized on the exchange. section 1031(b), however, provides that if any cash or non-like-kind property is received in the same transaction, the taxpayer must recognize the gain to the extent of the "boot" (cash or other dissimilar property) received. Under section 4.02(3) of Revenue Procedure 2005-14, boot is considered taxable on the productive-use part of the property only to the extent that the boot exceeds the gain excluded under IRC section 121.

In part, IRC section 1031(d) provides that the basis of property received in a like-kind exchange shall be the same as that of the property exchanged, decreased by any boot received and increased by any gain recognized. Under section 4.03 of the Revenue Procedure, when IRC sections 121 and 1031 are both applied, the gain excluded under section 121 is treated as gain recognized for purposes of computing the basis of the replacement property.

Three Scenarios

Revenue Procedure 2005-14 envisions three alternative property-use combinations where both provisions can apply. In one, a principal residence is fully converted to productive-use property prior to disposition. In the second, the property is used partly as principal residence and partly for productive use, with the productive-use part located in a separate structure. The third is like the second, except that the residence and the productive-use property are located in the same dwelling unit The following examples correspond to the three possibilities. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.