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Table of Contents

• Partial home sale exclusion allowed for adoption.
• Partial home sale exclusion allowed for death threat.
• No deduction allowed for dual-use rooms in bed-and-breakfast.
• Questions and Answers
  • Could your residence be the ultimate tax shelter?
  • Is residential accumulated depreciation taxed as ordinary income?
  • How will property without a residence be taxed?
  • How will land sold adjoining my home be taxed?
  • Is getting married an unforeseen circumstance?
  • Is buying a new home for a crippled guest an unforeseen circumstance?
  • How will I be taxed on the residence interest my mother gave me?
  • Can I still apply the principle residence exclusion if I rent my home?
• Visit our new article!
• Do you have other tax issues?
• Subscribe to the Real Estate Tax Letter

Partial home sale exclusion allowed for adoption.

The IRS has privately ruled that an adoption qualified as an unforeseen circumstance for which taxpayers were allowed to claim a partial home sale exclusion. Under the state law, the taxpayers would not have been allowed to adopt their daughter unless she had a separate bedroom from their other children, who were boys.

Under the general rule, taxpayers may exclude up to $250,000 of gain from the sale of a principal residence ($500,000 for married couples that meet certain requirements), provided they owned and used the property as their principal residence for two out of five years before the sale. The exclusion may only be used once every two years.

If the taxpayer(s) have to sell the residence because of unforeseen circumstances, a reduced exclusion can be claimed based on the ratio of the shorter of (1) the period of time the home was owned or (2) the period of time the home was used as a principal residence over 24 months or 730 days, depending on how the period of time is measured.

(LTR 200613009.)

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Partial home sale exclusion allowed for death threat.

A police officer and his family sold their family home because of death threats relating to the arrest of a drug dealer. The police officer did not live in the home for more than two years, as required under the general rules for exclusion of gain from the sale of a principal residence.

The IRS privately ruled sale qualified as made under unforeseen circumstances, qualifying for a partial exclusion.

(LTR 200615012.)

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No deduction allowed for dual-use rooms in bed-and-breakfast.

The Tax Court disallowed deductions for expenses relating to parts of a bed-and-breakfast used for both personal and business purposes.

The court rejected the owner’s argument that the use of an area was so commercial and different from a personal residence that the disallowance/exclusive use rules shouldn’t apply or that personal use was so minimal it should be disregarded.

In this case, some parts of the bed and breakfast were used solely for business (room rental), some solely personal (residence of the owner), and some dual-purpose. Dual-purpose areas included the lobby, registration area, office, kitchen and laundry room.

Moral – to qualify for the maximum tax deductions, the owner shouldn’t live in a hotel or bed- and-breakfast.

(Anderson, T.C. Memo. 2006-33.)

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Questions and Answers

Dear readers:

Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" (www.taxtrimmers.com/residence.shtml) where you should be able to find the answers to most of these questions.

Question

I believe an article that I read on your site is misleading. Isn’t gain up to the accumulated depreciation for a residence taxable as ordinary income?

Answer

No. It is long-term capital gain taxed at a special tax rate. Assuming the residence has been held more than one year, the (straight-line) depreciation is subject to tax at a higher rate (25%) than other long-term capital gains (15%). Generally, the gain up to the accumulated depreciation is not eligible for the exclusion for sale of a principal residence.

Question

We purchased a home site in 2000, but never built the home. Now we want to sell the property, which has appreciated considerably over the past three years.

Answer

Your gain for selling the property will be a long-term capital gain, qualifying for the 15% federal tax rate. (California gives no break for capital gains. For most taxpayers, the applicable tax rate is 9.3%.) Since the property was never used for a residence, the gain won’t qualify for the exclusion of gain from the sale of a principal residence. If you are interested in tax-deferral, you could plan a tax-deferred exchange to invest in a different piece of real estate.

If you live in California, you could have 3 1/3% of the sales price withheld for as a prepayment of California income taxes.

Hope this helps.

Question

We owned 18 acres on one plot, not a divided parcel, with a double-wide mobile home. We sold 11 acres on March 13, 2006 and build a house on the remaining 7 acres with the money from the sale. Are we subject to paying taxes on the capital gain, despite rolling the profit into the new house?

The double-wide mobile home was located on the 7 acres that we kept. We gave it away because we couldn’t find a buyer and to avoid the expense of having it moved.

Answer

The old rules of "rolling over" gains from a previously-sold residence were repealed in 1997.

It appears to me the gain for the sale of land in 2006 will be taxable long-term capital gain, to be reported on your 2006 income tax returns.

There is a rule that, if you sell the dwelling unit in a qualifying transaction within two years after the sale of the adjacent land, you can amend the tax return for the sale of the land and claim the exclusion. (Regulations Section 1.121-1(b)(3).)

Question

My son bought a bachelor condo a year ago. Now he has met someone and is getting married. They are looking for a house, because the condo is too small for two people. He has made a small profit and is wondering if he will have to pay income taxes on the capital gain? Is this an "unforeseen circumstance"?

Answer

There is no ruling on this point, but the IRS has been surprisingly liberal in its interpretations of "unforeseen circumstances", so your son may well fall under that exception. Also, after paying commissions and other selling expenses, he may find he doesn’t have much of a gain to worry about.

Question

We now own a condo that my husband and I have lived in for a year. We are in the process of buying a house that has a bedroom and bathroom downstairs. We are buying the other house because my mom, who will visit us soon, can’t climb the stairs to get into the condo.

Can we claim the exemption on the basis of health, since my mom had surgery and can’t climb stairs easily?

Answer

There is no ruling on this question. If your mom was moving the residence, I would say you would fall under the unforeseen circumstances exception. I think it’s questionable whether accommodating a visitor would qualify.

Again, after paying your selling expenses, will you have much of a capital gain?

Question

My mother added me as a joint owner of her home. I have been advised that when I sell the home after her death, I will be taxed on capital gains above the original purchase price in 1956. How can we change this situation?

Answer

I suggest that you and your mother consult with an attorney that specializes in estate planning.

When your mother added you as a joint tenant, she made a taxable gift that should be reported on a gift tax return.

I believe the advice you received was in error, but it’s not wholly good news. Since you acquired your interest in the property as a gift from your mother, the entire property is includable in her taxable estate, to be reported on her estate tax return, if one is required. (Internal Revenue Code Section 2040(a).

Since the property is includable in your mother’s taxable estate, the tax basis will be adjusted to the fair market value of the property on her date of death or the alternate valuation date. (Internal Revenue Code Section 1014(b)(9).)

You should help your mother get the facts about her estate tax situation, or discuss the matter with her lawyer or tax advisor. It may be the situation isn’t as bad as it appears to be.

Question

I will have owned my principal residence in Boston for two years in August. If I started renting the home after August, would I lose the exclusion for sale of a principal residence? What if I started renting the home before August?

Answer

If you started renting the home after owning and using it more than two years, you would have three more years during which you could claim the exclusion. The requirement is that you used the home as your principal residence for two years or more during a five-year period ending on the sale date.

If you start renting the home before August, you will lose the opportunity to qualify for the principal residence exclusion, unless you move back into the property at a later date.

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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

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IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.