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IRS Rules that Birth of a Second Child was "Unforeseen Circumstance" for Purpose of Section 121 Exclusion

(Parker Tax Publishing July 2016)

The IRS ruled that although a married couple had not owned and used their condo as their principle residence for two of the five years preceding its sale, they were eligible for a reduced maximum exclusion of income from the sale because the birth of the couple's second child was an unforeseen circumstance that necessitated the sale of the condo. PLR 201628002.

In PLR 201628002, married taxpayers had one child (a daughter) when they purchased a condominium. The condo had two small bedrooms and two baths. The child's bedroom served as the husband's home office as well as a guest room. After the purchase of the residence, the wife became pregnant and gave birth to another child (a son). In order to better accommodate the new child, the taxpayers moved out of condo, and sold the residence.

Because the taxpayers had used the condo as their principle residence for less than two of the five years preceding the date of the sale, they requested a private ruling from the IRS that the gain on the sale could be excluded under the reduced maximum exclusion in Code Sec. 121(c).

Code Sec. 121(a) provides that gain from the sale or exchange of property is not included in gross income if, during the 5-year period ending on the date of the sale or exchange, the taxpayer has owned and used the property as the taxpayer's principal residence for periods aggregating two years or more. The maximum gain excludable is generally limited to $250,000 ($500,000 for married taxpayers filing jointly).

Code 121(c) provides for a reduced maximum exclusion when a taxpayer fails to satisfy the ownership and use requirements if the primary reason for the sale is the occurrence of unforeseen circumstances. Reg. Sec. 1.121-3(e)(1) provides that a sale is by reason of unforeseen circumstances if the primary reason for the sale is the occurrence of an event that the taxpayer could not reasonably have anticipated before purchasing and occupying the residence.

Observation: Reg. Sec. 1.121-3(e)(2) provides a list of specific event safe harbors eligible for the "unforeseen circumstances" exception. These events include: (1) the involuntary conversion of the residence, (2) natural or man-made disasters, (3) death, (4) unemployment, (5) other adverse changes in employment status (6) divorce, or (7) multiple births resulting from the same pregnancy. The regulation states that the IRS may issue private rulings on situations not falling within the safe harbors. In such rulings, the IRS has found the unforeseen circumstances exception applies: where taxpayers have taken on additional dependents (e.g. newly adopted children or children from a prior marriage), where a taxpayer's adult child or disabled parent needed to move in with them, where criminal activity necessitated a move, and even where noise from a nearby airport was unbearable for the taxpayer.

The IRS concluded that the occurrence of unforeseen circumstances (i.e. the birth of the second child) was the primary reason for the sale, and that the suitability of the condo as the taxpayers' principal residence had materially changed. Accordingly, the IRS ruled that gain on the sale of the condo could be excluded under the reduced maximum exclusion of gain in Code Sec. 121(c).

For a discussion of the exclusion of gain from the sale or exchange of a principal residence, see Parker Tax ¶77,700.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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