Ownership of Home by Partnership Counts for Sec. 121 Purposes

H and W lived in Residence R since before year 1. They intend to sell R. In year 1, H and W transferred title in R to Partnership P. The transfer occurred in two steps. H and W first deeded 98% of R to Trust T, then H and W and T deeded R to P. T is a grantor trust formed by H and W, who have represented they are treated as T's owners under the grantor trust rules of Secs. 671-677. H and W each own a 1% interest in P as general partners; T owns the remaining 98% of P as a limited partner. The taxpayers also transferred several small rental properties to P in year 1. In year 2, P distributed title to R to its partners (H, W and T) in accordance with their partnership interests.

Analysis

Sec. 121(a) provides that a taxpayer's gross income will not include gain from the sale or exchange of property if, during the five-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as his principal residence for periods aggregating two years or more. Sec. 121(b)(1) provides that the amount of gain excluded from gross income under Sec. 121(a), with respect to any sale or exchange, will not exceed $250,000.

Sec. 121(b)(2)(A) provides that in the case of a husband and wife who make a joint return for the tax year of the sale or exchange of property, the Sec. 121(b)(1) exclusion is increased to $500,000, if (1) either spouse meets the ownership requirements of Sec. 121(a) for such property, (2) both spouses meet the use requirements of Sec. 121(a) for such property and (3) neither spouse is ineligible for the benefits of Sec. 121(a) for such property by reason of Sec. 121(b)(3).

Sec. 121(b)(3) provides the general rule that Sec. 121(a) will not apply to any sale or exchange by the taxpayer if, during the two-year period ending on the date of such sale or exchange, there was any other sale or exchange by the taxpayer to which Sec. 121(a) applied.

Rev. Rul. 66-159 considered whether the gain realized from the sale of trust property used by the grantor as his principal residence qualified for the deferment and rollover of gain into a replacement residence under Sec. 1034. The ruling held that, because the grantor was treated as the owner of the entire trust under Secs. 676 and 671, the sale by the trust would be treated for Federal income tax purposes as if made by the grantor.

Rev. Rul. 85-45 considered whether gain realized from the sale of trust property used by a trust beneficiary as his residence qualified for the one-time exclusion of gain from the sale of a residence under old Sec. 121. The ruling held that, because the beneficiary was treated as the owner of the entire trust under Secs. 678 and 671, the sale by the trust would be treated for Federal income tax purposes as if made by the beneficiary. Sec. 671 provides the general rule that, when a grantor or another person is treated as the owner of any portion of a trust, there will be included in computing the taxable income and credits of the grantor or other person those items of income, deduction and credit against tax of the trust attributable to that portion of the trust, to the extent that such items would be taken into account in computing taxable income or credits against an individual's tax.

Secs. 673–677 specify the circumstances under which the grantor is treated as the owner of any portion of a trust.

H and W have represented that they are treated as the owners of T under Secs. 671–677.

Ownership of Partnership Property for Sec. 121 Purposes

For a Federal tax law partnership to exist, the parties must, in good faith and with a business purpose, intend to join together in the present conduct of an enterprise and share in the enterprise's profits or losses. The determination requires weighing all of the facts and circumstances of a particular case. Because the existence of a partnership is based on Federal tax principles, an arrangement that constitutes a partnership under state law may not be a partnership under Federal tax law.

In the present case, R was not used in the conduct of an enterprise. P held title to R, but R did not yield any income to P or H and W, and R served no business purpose of P or H and W. Further, H and W (individually or as the grantors of T) owned 100% of R during the period that P held title to R, and have taken no business deductions (such as depreciation deductions) with respect to R.

Therefore, for Sec. 121(a) purposes, H and W will be treated as the owners of R throughout the period that P held title to R.

IRS Letter Ruling 200004022 (1/28/00)