This Sold House


The Tax Court recently held that a couple could exclude gain from the sale of one of their two residences, since during the five-year period preceding the home’s sale, it was used as the couple’s principal residence for the requisite two-year period. The taxpayers were not allowed to exclude the gain from the sale of an adjacent lot, however, because that property was titled to a family partnership.

Married taxpayers are permitted to exclude up to $500,000 of gain from the sale of a home if, during the five years preceding the sale, the residence was owned by either spouse and used by both spouses as their principal residence for periods totaling at least two years. Generally, only one sale every two years can qualify for the exclusion. Under Treas. Reg. § 1.121-1(b)(2), other factors used to determine a taxpayer’s principal residence are where the taxpayer works and banks; where the taxpayer’s family lives; the location of the taxpayer’s religious and recreational organizations; and the mailing address listed on the taxpayer’s tax returns, driver’s license, voter and driver’s registration, bills and correspondence. The gain from the sale of land adjacent to a principal residence that is owned by a taxpayer and used as part of that residence can also be excluded if the sale occurs within two years before or after the sale of the residence and all other section 121 requirements have been satisfied.

Dr. J. Ramsay Farah and his wife, Elizabeth, lived in Hagerstown, Md., where Dr. Farah operated a medical practice. In 1989 they purchased a vacation home in Berlin, Md., ultimately to be used as a retirement home. In 1991, a family partnership in which the Farahs each owned a 35% interest bought a 2.39 acre lot next to the Berlin home that they used as an additional yard. When the couple’s daughter attended college near Berlin in 1997, Mrs. Farah moved to the Berlin residence.

Meanwhile, Dr. Farah stayed largely on the road. He sold his medical practice in Hagerstown in 1998 and from May 1998 to May 2001 worked three days a week in Baltimore, 75 miles from Hagerstown and 138 miles from Berlin. He also traveled to clinics and medical facilities along the East Coast from Virginia to Maine. During that time, he lived at the Berlin home on non-workdays and weekends and returned to the Hagerstown home only about once a month.

In early 2001, after Mrs. Farah was diagnosed with cancer, the couple decided to move back to their Hagerstown home and sell the Berlin property. They listed it for sale that March and sold it in October for $1.3 million.

The IRS argued that the Hagerstown home was Dr. Farah’s principal residence from June 1998 to May 2001, since it was closest to his Baltimore work location and the Hagerstown address was used as a mailing address for tax returns, driver’s licenses and vehicle and voter registrations.

The court was not persuaded. It instead held the Berlin home was Dr. Farah’s principal residence during that period, accepting his testimony that he had spent a greater amount of time there and that he used the Hagerstown mailing address only to provide a stable appearance for his business and professional activities.

The court did reject the Farahs’ contention that since they owned the adjacent lot in substance, the gain from its sale should also be excluded. The court held that the Farahs had the freedom to title the property under the partnership’s name but must also accept the consequences of that choice. They had 10 years to alter the form of ownership but chose not to and named the partnership as the owner when listing the property with a real estate agent.

The case illustrates how a dwelling originally held as a vacation or retirement home may, under the proper circumstances, qualify as a primary residence eligible for the gain exclusion of section 121, despite a homeowner’s distant work location and frequent absences.

n J. Ramsay and Elizabeth Farah v. Commissioner, TC Memo 2007-369

Prepared by Charles J. Reichert, CPA, ­professor of accounting, University of Wisconsin–Superior.


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