After May 6, 1997, Sec. 121 has operated to exclude from gross income gain from the sale of a qualifying personal residence, not to exceed $250,000 (for single filers) or $500,000 (for joint filers). The maximum is unavailable, however, to taxpayers who fail to meet Sec. 121s ownership, use and frequency-of sale-requirements. (For a discussion, see Dilley, Tax Planning for the Sale of a Principal Residence, TTA, January 2004 (Part I), and February 2004 (Part II) Under Sec. 121(c), taxpayers failing to qualify for the maximum exclusion may qualify for a reduced exclusion.

According to Temp. Regs. Sec. 1.121-3T(b),...for a taxpayer to claim a reduced maximum exclusion under section 121(c), the sale or exchange must be by reason of a change in place of employment, health, or unforeseen circumstances... (Emphasis added.) The regulations further set forth that whether the requirements are met depends onall the facts and circumstances. Under Temp. Regs. Sec. 1.121-3T(b)(5), one key requirement to qualify for the unforeseen circumstances exception is that the circumstances that gave rise to the residence sale or exchange were not reasonably foreseeable when the taxpayer began using the property as a personal residence.

In Letter Ruling 200403049, the taxpayers owned and resided in a home (H1). While residing there, family member A presumably ran afoul of the law; A was placed on probation and spent one year at a rehabilitation facility. During the period of time A was confined to the facility, the taxpayers sold H1 and purchased a replacement residence (H2) in a different neighborhood. The ruling does not mention whether the Sec. 121 exclusion applied to H1.

The ruling indicates that the taxpayers did not expect A to reside in H2 on a permanent basis. However, during the second month of the taxpayers period of residency in H2, A returned to live there pursuant to a court-ordered house arrest coupled with continuing rehabilitation counseling.

According to the ruling, the taxpayers neighbors did not welcome A into the neighborhood. Rather, they threatened A, interfered with As attempts to find employment and objected to A spending time in H2s yard. Lastly, As probation officer was stated to have held the belief that A would have a better chance of reducing the period of house arrest and probation if the taxpayers sold H2 and moved to another neighborhood.

The ruling held that the taxpayers primary reason for selling H2 was an unforeseen circumstance (i.e., the neighbors hostility). The facts in the ruling are not inconsistent with the fact patterns of the six examples in Temp. Regs. Sec. 1.121-3T(e)(3), which were intended to illustrate what unforeseen circumstances would qualify for the Sec. 121(c) reduced maximum exclusion. Perhaps further guidance will increase an understanding of the IRSs common-sense approach as to the circumstances that may be viewed as unforeseen.