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KASS: Circumstances may permit tax exemption

DEAR BENNY: For personal reasons, my wife and I sold our house about 15 months after we bought it. We were fortunate to have made a good profit, but now want to find out if we have to pay capital gains tax. – Sheldon

DEAR SHELDON: The answer: It depends.

In 1997, Congress authorized the up-to-$500,000 exclusion of gain ($250,000 if you file a single tax return) if you owned and used your main home for two out of the five years before sale. However, it opened the door for reduced exclusions under certain limited circumstances. Section 121(c) of the Internal Revenue Code specifically provides that even if a taxpayer did not own and use the house for the full two-year period, if the house has to be sold for specific reasons, the taxpayer may be entitled to a partial exclusion of the gain. In addition to that “safe harbor,” you may be able to convince the IRS you qualify for the partial exemption.

Let’s look at these items separately:

Change in employment

If you have to travel at least 50 miles farther from the house you sold because of a job transfer or to take a new job, and that was the reason you sold the home, you will be eligible for the partial exclusion.

However, even if you cannot meet the safe harbor, you still may be able to convince the IRS to allow the partial exemption based on “facts and circumstances.” The regulations include an example of a doctor who sold her condominium and moved only 46 miles. Because the primary reason for the sale was to allow the doctor quicker access to the hospital for emergency purposes, the IRS would allow the partial exemption based on the facts of this case.

Reasons of Health

To qualify for the partial exemption, the primary purpose of selling the house must be based on health. Health is rather broadly defined to include “the diagnosis, cure, mitigation or treatment of disease, illness or injury.”

But the IRS issued a precautionary note: S sale “that is merely beneficial to the general health or well-being of an individual is not a sale … by reason of health.”

Unforseen circumstances

Obviously, this is the more difficult category. Each of us, at one point in time, will face conditions which significantly impact on our lives and on our financial situation that could not be anticipated.

Nevertheless, it would be manifestly unfair to be faced with a crisis and have to sell your house before the two years are up, and have to pay full tax on the profit you made. Accordingly, Congress authorized the IRS to issue regulations governing this area.

According to the regulations, a sale “is by reason of unforeseen circumstances if the primary reason for the sale … is the occurrence of an event that the taxpayer could not reasonablv have anticipated before purchasing and occupying the resident.”

The IRS then lists several safe harbors:

*Involuntary conversion of the residence, for example, condemnation by a governmental agency.

*Natural or man-made disasters or acts or war or terrorism resulting in a casualty to the residence.

*Death of one of the owners of the property.

*Cessation of employment as a result of which the taxpayer is eligible for unemployment compensation.

*Change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses.

*Divorce or legal separation under a court decree.

*Multiple births resulting from the same pregnancy.

If you fall within one of these areas – and have owned and used your house during the time since it was purchased – you will be entitled to take the partial exclusion of gain.

Even if you cannot claim a safe harbor, you still may be able to convince the IRS that there are circumstances which forced you to sell before the two years were up.

If you are eligible for the partial exclusion – either because you meet the safe harbor tests or the facts and circumstances test – this exclusion is equal to the number of days of use multiplied by $500,000 divided by 730 days. Note that 730 days is two full years. If you are single, or do not file a joint tax return, change the $500,000 to $250,000.

If you have to sell your house before you have owned and used it for two full years, and if you will make a significant profit, it clearly is important to try to qualify for the partial exemption.

If you are in doubt, try to hang on to your house until you meet the two-year test.

Benny Kass is a practicing attorney in Washington, D.C. and in Maryland. He is not providing specific legal or financial advice to any reader. He wants readers to e-mail him, but cannot guarantee a personal response. He can be reached at: mailbag@kmklawyers.com.

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