Taxpayers generally can exclude up to $250,000 ($500,000 on a joint return) of gain on the sale of their principal residence. To qualify, a taxpayer must have used the property as his or her principal residence for at least two years during the five-year period preceding the sale. When a taxpayer uses more than one dwelling in a year, Treasury regulations section 1.121-1(b)(2) requires an examination of all facts and circumstances to determine a taxpayer’s principal residence. The regulation says the property a taxpayer used the majority of time during a year will ordinarily be considered his or her principal residence. In addition to usage, other factors include the (1) taxpayer’s place of employment, (2) location of family members, (3) address listed on tax returns, voter registration, driver’s license and vehicle registration, (4) taxpayer’s mailing address, (5) location of the taxpayer’s banks and (6) location of religious organizations and recreation groups.
On September 15, 1998, James and Jean Guinan, a retired couple, sold a residence located in Wisconsin they had purchased in March 1993. The couple also had owned a home in Georgia they sold in 1996. Upon the sale of the Georgia home, the couple bought a home in Arizona. From March 1993 to September 15, 1998, the Guinans occupied the Wisconsin residence for 847 days, the Georgia one for 565 days and the Arizona one for 375 days. The taxpayers originally had reported the gain on the sale of the Wisconsin residence on their 1998 federal income tax return but later filed an amended tax return requesting a refund of $45,009 based on excluding the gain. The IRS denied the request. The taxpayers filed an action with the U.S. district court in Arizona asking for a refund.
Result. For the IRS. The court examined the factors listed in regulations section 1.121-1(b)(2) to determine the taxpayer’s principal residence. It held that from 1993 to 1998, even though the Guinans had used the Wisconsin home for more days than either of their other two homes, they used it for the majority of only one year—1993 to 1994. The court noted it must consider the other factors in the regulations together with the time the couple spent at the residences to determine the Guinans’ principal residence, although usage probably was the most important factor. In examining these factors the court grouped them as (1) indicating the Wisconsin home was the couple’s principal residence, (2) indicating Wisconsin was not their principal residence or (3) factors with no impact on this question.
During the years in question, the Guinans received mail and had bank accounts at each residence. They kept a vehicle and two boats at the Wisconsin home, but also kept two vehicles at their other residences. The couple’s children did not live in any of the states where the Guinans had a residence. The couple enjoyed recreational activities at all locations. Thus the court held that these factors did not support or contradict the taxpayers’ position that the Wisconsin home was their principal residence. However, during the five-year period, the couple filed either a Georgia or Arizona state income tax return, were registered to vote in one of those states and had either Georgia or Arizona driver’s licenses. The court found these factors indicated the Wisconsin home was not their principal residence.
The one factor that supported the taxpayers’ contention the Wisconsin home was their principal residence was its size. The court held, however, that this was not enough to overcome the factors supporting the IRS position that it was not the principal residence. If the taxpayers, however, had used the Wisconsin residence 10 days more in either of two years, they would have used it for the majority of two of the five years in question. It’s unclear whether this usage, which the court acknowledged to be the most important factor, would have outweighed the other factors.
Clients who live in northern states frequently buy homes in southern states to spend the winter months in a warmer climate. Many of these taxpayers register their vehicles and change their voting registration to the southern states to be considered residents of those states. This typically enables them to pay lower state income taxes or no state tax at all. When taxpayers are contemplating selling a home in a northern state whose value has substantially appreciated, CPAs need to help them examine the factors necessary for that home to be considered their principal residence for at least two years. This may require reestablishing residency in the northern state. CPAs should weigh the higher state income taxes paid prior to the sale against the federal income taxes the taxpayer saves by having the northern home qualify as his or her principal residence.
J ames M. and Jean M. Guinan v. United States, 2003-1 USTC 50,475.
Prepared by Charles J. Reichert, CPA, CIA, professor of accounting at the University of Wisconsin, Superior.