Jeanne and Willis owned their home together. About the same time they divorced, they sold their principal residence for $380,000. After paying sales expenses, Jeanne’s half of the adjusted sales price was $178,056.
Less than two years after the divorce and home sale, Jeanne married Henry. They bought a home together for $179,357. On her income tax returns, Jeanne reported this as a replacement principal residence.
She claimed profit tax deferral under Internal Revenue Code 1034, the “rollover residence replacement rule, because she bought a replacement home of equal or greater cost within 24 months before or after the sale.
But the IRS denied the tax deferral, arguing Jeanne owes tax on her $69,518 profit from the sale of the old home. The IRS noted the replacement home was purchased by Jeanne and Henry so her share is only $89,678.50, and, because this is far less than her $179,357 share of the sale price, her entire sale profit is taxable. Jeanne took her dispute to the U.S. Tax Court.
Can Jeanne defer tax on her home sale profit?
The judge said no.
“If the cost of the new residence equals or exceeds the adjusted sales price of the old residence, the entire gain will be deferred. If the cost of the new residence is less than the adjusted sales price of the old residence, gain will be recognized to the extent of the difference,” the judge explained.
“Maintaining continuity of title is a key to receiving nonrecognition treatment under section 1034,” the judge continued. Both the old and new residences must be titled in the same names, he noted.
Although Jeanne could have avoided tax by taking title to the new residence in her name alone, that is not what she did, the judge emphasized. Because she took title with her new husband, Henry, her $89,678.50 share of the purchase price is far below her $179,357 sales price share of the former residence; so Jeanne’s entire $69,518 sale profit is taxable, the judge ruled.
Based on the 1995 U.S. Tax Court decision in Snowa vs. Commissioner, T.C. Memo 1995-336
One break limit
In 1980, Arthur sold his home at a profit of $11,360 and used his once-per-lifetime “over 55 rule” $125,000 home sale tax exemption. But in 1990, he sold another home at a profit of $137,824 and again claimed a $125,000 home sale tax exemption.
Upon IRS audit, Arthur explained his 1980 home sale really didn’t qualify for the $125,000 exemption because he was not yet 55 then. Also, because he used only $11,360 of the exemption, he should be entitled to use the balance on his 1990 home sale.
However, the IRS viewed the situation differently. Although Arthur wasn’t entitled to his 1980 use of this tax break because he wasn’t yet 55, the IRS auditor explained the three-year statute of limitations has run so Arthur cannot now “unelect” that use of Internal Revenue Code 121. Arthur took his dispute to the U.S. Tax Court.
Can Arthur claim his “over 55 rule” $125,000 home sale tax exemption on the 1990 sale of his home?
The judge said no.
The judge explained that even if Arthur’s 1980 use of the “over 55 rule” $125,000 home sale tax exemption was improper because was not yet 55, he is bound by that election. Because IRC 121 can only be used once per lifetime, Arthur cannot use the balance of his exemption now, the judge noted.
Because Arthur cannot “unelect” his 1980 use of the $125,000 home sale tax exemption, even though he had only $11,360 of home sale profits to shelter from taxes at that time, he must now pay $36,102 tax and penalties on his $137,824 home sale profit in 1990, the U.S. Tax Court judge ruled.
Based on the 1995 U.S. Tax Court decision in Koppen vs. Commissioner, T.C. Memo 1995-316.
