Study Unit 11: Nonrecognition Property Transactions

Anne, who is single, owned and used her house as her main home from January 2016 until January 2021. She then moved away and rented her home from February 2021 until she sold it in August 2022. Her home sold for $240,000 (which included $20,000 of depreciation) and $12,000 of selling expenses. Using a zero basis, compute the amount that is excludable from income.

• $208,000

• $220,000

• $228,000

• 
  $240,000

Answer explanation

The taxpayer may exclude $250,000 ($500,000 for married taxpayers filing jointly) of a realized gain on the sale of a principal residence. The exclusion is available if the individual owned and occupied the residence for an aggregate of at least 2 of the 5 years before the sale. The gain on sale must be prorated between qualified and nonqualified use. Nonqualified use includes periods that the residence was not used as the principal residence of the taxpayer, prior to the last day the homeowner lived in the house. Since all of Anne’s nonqualified use occurred after the last day she lived in the house, there are zero periods of nonqualified use. Any selling expenses incurred reduce the amount realized, therefore Anne’s amount realized is $228,000 ($240,000 – $12,000). Also, any gain equal to depreciation allowed or allowable may not be excluded. The amount that is excludable is therefore $208,000 ($228,000 amount realized – $20,000 depreciation).

Roy and Joyce were single, and each owned a home as a separate principal residence for a number of years. In August 2021, Roy sold his home and had a gain of $130,000, which he entirely excluded. Roy and Joyce were married in October 2022. Joyce then decided to sell her principal residence for a $350,000 realized gain. They plan on filing a joint return for 2022. How much of the gain from the sale of Joyce’s home can be excluded on their joint tax return for 2022?

• $0

• 
  $100,000

• 
  $250,000

• 
  $350,000

Answer explanation

An individual may be able to exclude up to $250,000 of gain on the sale of a personal residence. This exclusion amount is $500,000 for married taxpayers filing jointly if the use and ownership requirements are met and if neither spouse has used the exclusion in the previous 2 years. But even if a single individual marries someone who has used the exclusion within 2 years before marriage, the qualifying individual is not precluded from claiming the $250,000 exclusion to which (s)he is entitled. Thus, Joyce may still claim the exclusion of $250,000 on the joint return and must recognize only $100,000.

Which of the following statements is NOT a requirement that must be met before married taxpayers filing jointly can elect to exclude up to $500,000 of the gain on the sale of a personal residence?

• 
  Either taxpayer must be age 55 or over at the date of the sale.

• Either spouse must have owned the home as a principal residence for 2 of the 5 previous years.

• 
  Both spouses must have used the home as a principal residence for 2 of the 5 previous years.

• 
  Neither spouse is ineligible for the exclusion by virtue of a sale or exchange of a residence within the last 2 years.

Answer explanation

Certain married individuals filing jointly may exclude up to $500,000 on the sale of a principal residence. Married individuals are eligible for a $500,000 exclusion if (1) either spouse owned the home as a principal residence for 2 of the 5 previous years, (2) both spouses used the home as a principal residence for 2 of the 5 previous years, and (3) neither spouse is ineligible for the exclusion by virtue of a sale or an exchange of a residence within the last 2 years. But even if one spouse does not meet the use test, a $250,000 exclusion may still be available for the sale. The age limitation of 55, however, is no longer applicable to the exclusion.

Steve and Karen, a married couple, purchased a new residence on May 1, 2020. They sold their prior home on July 1, 2021, and realized a gain of $250,000, all of which they excluded. They sold the new home on August 1, 2022, because they wanted to live in a condo. What is the maximum amount of the gain they may exclude in 2022?

• 
  $0

• 
  $135,417

• $270,833

• $500,000

Answer explanation

Since the taxpayers sold another residence within 2 years of the 2022 sale, the exclusion is not allowed.

John bought his principal residence for $250,000 on May 3, 2021. He sold it on May 3, 2022, for $400,000. What is the amount and character of his gain?

• Long-term, ordinary gain of $650,000.

• 
  Long-term, capital gain of $150,000.

• Short-term, ordinary gain of $650,000.

• Short-term, capital gain of $150,000.

Answer explanation

Real property not used in trade or business is a capital asset (e.g., principal residence). Short-term capital is any capital held for 12 months or less starting with the day after acquisition and ending on the day of the sale. Because this sale took place within the prescribed 12-month period, it is classified as a sale of short-term capital property. Additionally, since John does not meet the ownership and occupancy requirements to qualify for an exclusion of gain upon the sale of a principal residence, John’s gain is the full $150,000 ($400,000 – $250,000).

When Amelia bought her first home in 2019, she paid $100,000 plus $1,000 closing costs. In 2020, she added a deck that cost $5,000. Then, in July of 2022, a real estate dealer accepted her house as a trade-in and allowed her $125,000 toward a new house priced at $200,000. How should Amelia report this transaction on her 2022 return?

• $19,000 long-term capital gain.

• 
  No reporting because the trade is not a sale.

• $0 taxable gain and reduce her basis in her new house by $19,000.

• 
  No reporting required.

Answer explanation

Amelia has a $19,000 [$125,000 trade-in – ($100,000 purchase price + $1,000 closing cost + $5,000 deck)] long-term capital gain on the disposition of her house. However, a taxpayer may exclude up to $250,000 of gain on the sale of a principal residence. The exclusion is available if the individual owned and occupied the residence as a principal residence for an aggregate of at least 2 of the 5 years before the sale. If the amount of the realized gain is less than the maximum exclusion amount, the gain need not be reported.

Joe had a taxable gain on the sale of his main home, which could not be excluded on his 2022 tax return. He had no business use of the home. Which schedule does he need to submit to report the gain?

• Schedule C, for sole proprietors.

• Schedule A, for itemized deductions.

• Schedule D, for capital gains.

• Schedule SE, for self-employment income.

Answer explanation

A personal residence is a capital asset. When the taxpayer cannot exclude a portion or all of the gain from the sale of principal residence, the gain is reported on Schedule D.

Clyde, a single person, sold his principal residence for $700,000. He purchased his home 10 years ago for $150,000 and lived there until he sold it. He paid for capital improvements of $75,000, real estate commissions of $36,000, and other settlement costs of $4,000. How much taxable gain must Clyde report?

• $0

• $185,000

• 
  $435,000

• $225,000

Answer explanation

A taxpayer may exclude up to $250,000 ($500,000 for a joint return) of a gain on the sale of a principal residence if (s)he primarily resided in this home for 2 years of a 5-year period before the sale of the home. The gain is determined by subtracting the adjusted basis of $225,000 ($150,000 purchase price + $75,000 capital improvements) from the amount realized of $660,000 ($700,000 sale price – $36,000 commissions – $4,000 settlement cost). This yields a gain of $435,000. Clyde only has to claim $185,000 ($435,000 – $250,000 exclusion) as a gain (Sec. 121).

Pete purchased his home on June 1, 2013. On June 1, 2018, Pete became physically incapable of self-care and entered a licensed care facility. Pete sold the residence on April 15, 2022. Pete was residing in the facility at the time of sale. Pete had purchased the home for $150,000, and he sold the home for $300,000. What is Pete’s recognized gain for 2022?

• $300,000

• 
  $250,000

• $150,000

• $0

Answer explanation

If an individual becomes physically or mentally incapable of self-care, the individual is deemed to use a residence as a principal residence during the time when the individual owns the residence and resides in a licensed care facility. To apply, the individual must have owned and used the residence as a principal residence for an aggregate period of at least 1 year during the 5 years preceding the sale or exchange. Pete met these requirements, so the gain is excluded.

Robert purchased his home for $150,000 in 2012. He sold it for $350,000 (including $100,000 for the land) in 2022. This was his primary residence until it was sold. However, Robert claimed one-fifth of his home as an office for his self-employed business. He claimed a total of $6,000 depreciation over the years. The $150,000 purchase was assessed at $90,000 building and $60,000 land. What is Robert’s taxable income as a result of the sale of this primary residence?

• $6,000

• $38,000

• $200,000

• $0

Answer explanation

Under Reg. 1.121-1(e)(i), no allocation of gain is required if both the residential and nonresidential portions of the property are within the same dwelling unit. However, Sec. 121 will not apply to the gain to the extent of any post-May 6, 1997, depreciation adjustments. Thus, the $6,000 depreciation taken must be reported as ordinary income.