Home-Sale Exclusion Rules for Taxpayers Affected by September 11

In Notice 2002-60, the IRS announced special home-sale exclusion rules for homeowners affected by the September 11 terrorist attacks. Taxpayers who sold or exchanged their principal residence before meeting the usual two-year requirement might qualify for a reduced maximum exclusion of the gain realized on the transaction, if the sale arose from unforeseen circumstances. The sale gain would be partially based on the proportion of days or months of use or ownership.

Qualified Taxpayers

A taxpayer is considered affected for exclusion purposes if:

1. The “qualified individual” (i.e., taxpayer, his or her spouse, a co-owner of the residence or a person whose principal residence is in the same household as the taxpayer) was killed;

2. The taxpayer's principal residence was damaged (regardless if he or she is entitled to casualty losses);

3. The qualified individual lost em-ployment and became eligible for unemployment compensation; or

4. The qualified individual had a change in employment or self-employment that resulted in his or her inability to pay reasonable, basic household living expenses.

Sec. 121

Under Sec. 121, a taxpayer can ex-clude up to $250,000 ($500,000 for married filing jointly) of the gain on the sale or exchange of his or her primary residence. The property must be owned and used as the taxpayer's principal residence for two of the last five years before the sale. This exclusion may be used only once during a two-year period. Sec. 121 allows a reduced exclusion for anyone not meeting that section's requirements because of a change in employment, health or unforeseen circumstances.

Sec. 121 proposed regulations, issued in October 2000, stated that the final regulations will provide guidance on the meaning of “unforeseen circumstances,” which includes the death of a taxpayer's spouse, manmade disasters and acts of war. The Service will have further discretion to determine other circumstances that qualify as unforeseen.

Computation of Reduced Maximum Exclusion

The $250,000 maximum exclusion amount ($500,000 for certain joint filers) is multiplied by a fraction to determine the reduced exclusion amount. The numerator is determined as the shorter of:

1. The period a taxpayer owned the property within the five years preceding a sale.

2. The period in which a taxpayer used the property as his or her principal residence within the five years preceding a sale.

3. The period between the date of a previous sale or exchange, in which the taxpayer excluded gain under Sec. 121, and the date of the current sale or exchange.

The fraction's numerator is in days or months. The denominator is either 730 days or 24 months, depending on the numerator. For a single taxpayer who owned and used a residence for one year prior to a sale, the exclusion would be $125,000 ($250,000 x 365/730 (one-half the required time period)).

Taxpayers who qualify could file amended returns to claim the exclusion under Notice 2002-60.

From Denise Barb, CPA, Gray, Gray & Gray, LLP, Westwood, MA