"Unforeseen Circumstances" Exclusion From Gain on Sale of Home

Regulations and private letter rulings offer examples of situations the IRS has approved as qualifying for partial exclusion of gain.

D espite the recent downturn in the American housing market, one of the highest-value assets owned by most taxpayers remains their home. While many taxpayers have seen the value of their home decline, those in locales where home values have remained relatively strong—such as parts of some Southern and Midwestern states—could still realize a gain upon the sale of their home. Those now buying homes in depressed regions at what they hope are market-bottom prices will likely realize a gain after markets recover.


Single taxpayers or those married filing separately generally can exclude up to $250,000 of the gain from the sale or exchange of a home ($500,000 for married taxpayers filing jointly). This exclusion may be taken once every two years if the taxpayers have owned and used the property as a principal residence for a period of (or periods totaling) at least two years during the five-year period ending on the date of the sale or exchange. Taxpayers who don’t meet these conditions can qualify for a reduced exclusion under IRC § 121(c) if the sale or exchange is because of a change in place of employment, health or “unforeseen circumstances.”



Employment . Treas. Reg. §§ 1.121- 3(c)(1) and (2) provide that a sale or exchange is by reason of a change in place of employment if (1) the change occurs during the period when the taxpayer owns and uses the property as a principal residence and (2) the taxpayer’s or other qualified individual’s new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment. If there was no former place of employment, the distance between the qualified individual’s new place of employment and the residence sold or exchanged must be at least 50 miles. The new place of employment may be with the same or a different employer or can include the beginning or continuation of self-employment (Treas. Reg. § 1.121-3(c)(3)). A qualified individual is the taxpayer, the taxpayer’s spouse, a co-owner of the residence or a person whose principal place of abode is in the same household as the taxpayer (Treas. Reg. § 1.121-3(f)).


Health. A sale or exchange is for health reasons if it is primarily to provide medical diagnosis, treatment or care for a qualified individual’s disease, illness or injury or to provide personal care. Qualified individuals include those for purposes of a change of employment, plus their family members and certain other relatives. A change of residence must be more than merely beneficial to general health or wellbeing unless recommended by a physician. See Treas. Reg. § 1.121-3(d).


Unforeseen circumstances. Unforeseen circumstances are defined by Treas. Reg. § 1.121-3(e)(1) as events the taxpayer could not reasonably have anticipated before purchasing and occupying the residence. Specific-event safe harbors are provided in Treas. Reg. § 1.121-3(e)(2): involuntary conversion of the residence; disasters or acts of war or terrorism damaging the residence; or a qualified individual’s death, unemployment (if eligible for unemployment compensation), change in employment status that results in an inability to pay housing costs and basic living expenses, divorce or legal separation  under a decree of divorce or separate maintenance, or a multiple birth. These, however, are hardly all the common life events that can result in the sale or exchange of a home, such as marriage, adoption or other circumstance that results in the addition of dependents to the family. Despite not being specified as safe harbor events, circumstances such as these and others may still qualify as unforeseen. Determining whether fact patterns exhibit the level of unforeseeability necessary to qualify as unforeseen circumstances requires taxpayers and practitioners to exercise their best judgment.



The following summarizes the 15 letter rulings that were issued from Aug. 13, 2004 (the date final regulations were issued under IRC § 121), through August 2009 that have addressed whether given facts and circumstances qualify as unforeseen despite falling outside the specific- event safe harbors. In each case, the IRS found that unforeseen circumstances were present and granted the taxpayer partial gain exclusion relief under section 121(c); no unfavorable rulings were issued. The rulings can be broadly characterized as relating to (1) additional dependents arising out of marriage or other events, (2) environmental factors that detrimentally affect the quality of living in a particular locale and (3) job-related circumstances. Although the rulings may not be cited as precedent and do not establish a safe harbor of general applicability, they do provide a basis for understanding what circumstances the IRS is likely to consider unforeseen.



Life events the Service has most frequently ruled upon are those taxpayers did not plan when they purchased a residence and that increased the number of dependents living under one roof. They include the addition of children via pregnancy, adoption or second marriage, and providing in-home care for a parent who became ill or disabled. Here are summaries of these rulings (in chronological order) and their circumstances:


Blended family moves to children’s school district. PLR 200601022. The taxpayer owned a residence before getting married. After marrying, the taxpayer and his family moved into a new home because the taxpayer’s original residence was outside the school district the spouse’s children attended. The taxpayer intended to return to the original residence after his spouse’s children graduated from school. However, after the family moved to the new home, the taxpayer and his spouse had a child, and the taxpayer’s original residence was no longer large enough for their family. The taxpayer therefore sold the original residence.


Adult child moves back in with parents. PLR 200601023. The taxpayers retired, sold their house, moved to another state, and purchased another home. After the move, the taxpayers’ married daughter, who lived apart from them, lost her job and divorced her husband. The daughter and her child needed to live with the taxpayers. However, age restrictions in the taxpayers’ community prevented such an arrangement. The taxpayers therefore sold their new home, relocated to their original state, and purchased another home, where the daughter and grandchild could live with them.


Bigger house for adoption. PLR 200613009. The taxpayers, who along with their three sons occupied a three-bedroom house, decided to adopt an orphan girl from a foreign country. While in the process of adopting the girl, the taxpayers learned that state law would require that she have her own bedroom. To provide suitable accommodations, the taxpayers sold their residence and rented a larger home with an extra bedroom.


Caring for disabled parent. PLR 200626024. A taxpayer purchased a residence for himself and his three children. After the taxpayer got married, his new wife and her two children moved into the residence. As the result of an illness, the wife’s mother was partially paralyzed and moved into the residence because of her special needs. To provide the wife’s mother with the space necessary for her special care and accommodations, the taxpayer and his wife sold the residence and purchased a new home.


Pregnancy and end of relationship. PLR 200652041. An unmarried man and woman jointly purchased a house. Seven months later, the woman discovered that she was pregnant by the man. They were no longer in a relationship. They planned to sell the house and find separate residences because the house was not large enough to accommodate two adults and a child and neither taxpayer could afford to make the monthly mortgage payments on the house alone.


Large blended family. PLR 200725018. Two married taxpayers each owned three-bedroom houses before their marriage. From their previous marriages, one taxpayer had three children and the other taxpayer had two children. They sold their houses and together purchased a new four-bedroom home to provide suitable sleeping arrangements for their blended family, which included adolescent children of the opposite sex.


Second child and home office. PLR 200745011. Married taxpayers purchased a three-bedroom house for themselves and their child. The taxpayers used one of the bedrooms as an office. After the birth of a second child, the taxpayers tried but failed to make reasonable accommodations for the additional child. The taxpayers purchased a larger three-bedroom house that included additional space for use as their office.


Blended family and schools. PLR 200826024. Two taxpayers both owned homes before their marriage. From their previous marriages, one taxpayer had two preadolescent daughters and the other had one adolescent son. Because the layout of one house would not provide adequate privacy for the blended family, that taxpayer sold it and moved, along with her two daughters, into the other house. In addition, by choosing to combine the families in that house, the parents were able to keep all the children in the schools they attended before the marriage.


Marriage with visiting child. PLR 200841022. Taxpayer A owned a house and had a long-standing relationship with his nonresident daughter, who regularly visited on weekends and school holidays. Taxpayer B had two children, a boy and a girl. Taxpayers A and B married and purchased a new four-bedroom residence to suitably accommodate themselves, Taxpayer B’s children and Taxpayer A’s visiting daughter. Taxpayer A sold his original three-bedroom house.



The IRS has also granted taxpayers relief under section 121(c) in instances where crime or acts of violence or even noise detracts from the taxpayer’s ability to maintain a satisfactory quality of living in a particular location.


Assaults and threats. PLR 200601009. A couple moved to a new state and purchased a new house because of a new job. They became aware of criminal activities in their neighborhood. After a neighbor assaulted one of them and their son was assaulted and threatened, the taxpayers sold the house and purchased another home.


Robbery. PLR 200630004. As the taxpayer was leaving home, an assailant held a gun to the taxpayer’s head, made repeated threats upon the taxpayer’s life and for approximately one hour forced the taxpayer to drive the assailant to several locations. The traumatic and violent nature of the crime prompted the taxpayer to move into a new residence.


Aircraft noise. PLR 200702032. After living in an apartment, the taxpayer bought a house the same distance away from an airport but in a different direction from it. Soon thereafter, the taxpayer sold the house at a loss, claiming that aircraft noise made it uninhabitable. A cash settlement received from suits against the sellers and other parties was properly treated as proceeds from the sale of the residence. The gain realized was determined to be excludable under section 121(c) because the taxpayer submitted evidence to show that despite having made a reasonable investigation of the property, he had no reason to anticipate how much noise would result from airport operations and that he would not have purchased the property had he known. An airport authority official said in an affidavit that runway patterns made noise at the house five times greater than at the apartment. Note, however,

that traffic noise is generally considered foreseeable if a home, when purchased, is on a heavily traveled road (Treas. Reg. § 1.121-3(e)(4), Example 5).


Child assaulted on school bus. PLR 200820016. The taxpayer purchased a house as the principal residence for herself and her two daughters. While riding the school bus, one of the daughters was subjected to unruly behavior, verbal abuse and sexual assault. The traumatic nature of the crimes created fear and caused the daughter’s performance at school to deteriorate. After trying to work with the school district to resolve these problems, the taxpayer finally sold her house to move her daughter away from the problems.



The IRS has also granted taxpayers relief under section 121(c) in at least two instances where circumstances changed as a result of the taxpayer’s occupation.


K-9 officer. PLR 200504012. A taxpayer employed as a police officer purchased a townhouse governed by a homeowners association that prohibited its residents from maintaining a kennel. The taxpayer was selected to become a K-9 officer. Because K-9 officers are required to care for a dog and maintain a kennel at their residence, the taxpayer sold the townhouse.


Narcotics investigator threatened. PLR 200615011. A taxpayer who worked as a police narcotics investigator conducted a highly publicized arrest of an alleged drug dealer. Associates of the alleged drug dealer discovered the taxpayer’s home address and planned to kill the taxpayer in his home. In response to the threat, the taxpayer sold the house and moved.



The reduced maximum exclusion is computed by multiplying the maximum dollar limitation ($250,000 or $500,000) by a fraction. The numerator of the fraction is the shortest of the following periods of time: (1) the taxpayer’s ownership of the property during the five-year period ending on the date of the sale or exchange, (2) the taxpayer’s use of the property as the taxpayer’s principal residence during the five-year period ending on the date of the sale or exchange, or (3) the length of time between the date of a prior sale or exchange of property for which the taxpayer excluded gain under section 121 and the date of the current sale or exchange. The denominator of the fraction is 730 days or 24 months (depending on whether the numerator is measured in days or months).


Example . A single taxpayer purchased a home on July 15, 2008, that she uses as her principal residence. On July 14, 2009, she sells the house because of a change in her place of employment. The taxpayer has not excluded gain under IRC § 121 on a prior sale or exchange of property within the last two years. She is eligible to exclude up to $125,000 of the gain from the sale of her house [(12 months ÷ 24 months) × $250,000].





  Exclusion of gain from sale or exchange of a principal residence under IRC § 121 is generally available only once every two years and when the taxpayer has owned and used the home as a principal residence for a period of, or periods totaling, two years during the five-year period ending on the date of the sale or exchange.


  However, taxpayers who do not meet these conditions may still qualify for a partial exclusion if the sale or exchange is because of a change in health, place of employment or “unforeseen circumstances.” The latter reason is defined by regulation to include several safe harbors: involuntary conversion, casualty, death, unemployment, divorce or legal separation, or multiple births. Other circumstances may also qualify if they are judged incapable of being reasonably foreseen before the taxpayer purchased and occupied the residence.


  To date, the IRS has issued 15 private letter rulings on various scenarios not covered by the safe harbors in the regulations. All qualified as unforeseen. Although they apply only to the taxpayers who requested them, they may be taken as an indication of the types of instances where taxpayers in similar circumstances may obtain a partial exclusion of gain. They may be categorized as (1) those that increase the number of dependents living under one roof, (2) environmental factors such as crime or noise or (3) job-related factors.


David W. Randolph (randolphd1@xavier.edu) is an assistant professor of accounting at the Williams College of Business, Xavier University, in Cincinnati.


To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at pbonner@aicpa.org or 919-402-4434.






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