Normally, a taxpayer must reside in a home as a principal residence for at least two of the previous five years before taking advantage of the capital gains exclusion of IRC § 121(a) on the sale of the home. A taxpayer may exclude up to $250,000 of gain; married taxpayers filing a joint return may exclude up to $500,000 of gain if they meet the conditions of section 121(b)(2).
The ruling involved a taxpayer called “Bill,” who has two children. He married “Andrea,” who has three children. Bill and Andrea each sold their principal residences so they could buy a larger home to accommodate the larger combined family. Bill owned his residence for less than two years.
The IRS said that under Treas. Reg. § 1.121-3(e)(1) the marriage and combining of families was an event the taxpayer could not reasonably have anticipated before buying his old residence. The event also altered “the suitability of the property as the taxpayer’s principal residence” under Treas. Reg. § 1.121(b)(2). The IRS agreed that a larger home with more bedrooms was needed to suitably accommodate a blended family that includes adolescent children of the opposite sex.
The ruling does not say how long Bill owned the residence or the amount of any gain he had from the sale. In any case, he would only be allowed to claim a pro rata portion of the $250,000 exclusion, as calculated under IRC section 121(b)(1).