Complications With The 121 Exclusion

05.05.2014

By: Judson M. Stein

IRC section 121 allows a taxpayer to exclude up to $250,000 ($500,000 for certain taxpayers who file a joint return) of the gain from a sale/exchange of property owned and used as a principal residence for at least 2 of the last 5 years before the sale. A taxpayer can claim the full exclusion only once every two years and the taxpayer doesn’t even have to purchase a replacement home to exclude the gain.

A surviving spouse who owned a property as joint tenants with their spouse is also entitled to relief through the sale of their personal residence.  If the sale of personal residence occurs within 2 years after the death of the predeceased spouse, the surviving spouse is able to take advantage of the full $500,000 exclusion (unless the surviving spouse remarries within the 2 year period).  To illustrate, refer to the below example.

121-ex-fact-pattern

At Harry’s death in July 2012, the couple’s basis in their house was $200,000 and its fair market value was $500,000.  Harry’s 1/2 interest in the property receives a step up in basis to 1/2 of the fair market value at the date of his death, to $250,000.  In February 2014, Wendy sells the property for $600,000.  The couple total adjusted basis in the property is Harry’s basis of $250,000 plus Wendy’s basis of $100,000 (1/2 basis at date of purchase) for a total basis of $350,000.  Without the 121 exclusion, the gain recognized from the sale of the property would be $250,000 (600,000-350,000). However, because Wendy sold the property within 2 years of Harry’s death, she is entitled to the full $500,000 121 exclusion.

Tag: Income Tax Planning