A homeowner who may exclude gain upon a sale or exchange of a home may also benefit from a deferral of gain for a like-kind exchange with respect to the same property.
Generally, a homeowner may exclude up to $250,000 ($500,000 for certain joint returns) of gain from the sale or exchange of a home. The homeowner must have owned and used the property as his or her principal residence, for periods aggregating two years or more, during the five-year period ending on the date of the sale or exchange, and must not have used the exclusion during the two-year period ending on that date. Owners of property held for productive use in a trade or business may defer gain from the sale or exchange of such property if they follow the rules of Code Sec. 1031. While property used solely as a home would not constitute business property, many homeowners have home offices or have other business uses for their home. The home-sale exclusion might apply to a home office, or other business portion of a home, but does not apply to depreciation from the business use of the home. On the other hand, a business property owner may defer gain upon the exchange of his business property for like-kind replacement property.
The new revenue procedure indicates that, in certain cases, a homeowner may benefit from both the home-sale exclusion and a like-kind deferral. In such cases, the property would have been used consecutively or concurrently as a home and a business (e.g. rental residence).
Skip buys a house for $210,000 that he uses as his principal residence from 2000 to 2004. From 2004 until 2006, Skip rents the house to tenants and claims depreciation deductions of $20,000. In 2006, Skip exchanges the house for $10,000 of cash and a townhouse with a fair market value of $460,000 that Skip intends to use as rental property. Skip realizes gain of $280,000 on the exchange ($460,000-(210,000-20,000)+$10,000=$280,000).
Skip's exchange of a principal residence that he leases for less than 3 years for a townhouse he intends to use for rental and cash satisfies the requirements of both Code Sec. 121 and Code Sec. 1031. Because Code Sec. 121 does not require the property to be the taxpayer's principal residence on the sale or exchange date and Skip has owned and used the house as a principal residence for at least 2 of the 5 years prior to the exchange, Skip may exclude gain under Code Sec. 121. In addition, since the house is investment property at the time of the exchange, Skip may defer gain under Code Sec. 1031. Thus, under Rev. Proc. 2005-14, §4.02(1), Code Sec. 121 applies to exclude $250,000 of the $280,000 gain before applying the nonrecognition rules of Code Sec. 1031. Therefore, Skip may defer the remaining gain of $30,000, including the $20,000 gain attributable to depreciation, under Code Sec. 1031. Moreover, although Skip received $10,000 of cash (boot) in the exchange, he is not required to recognize gain because the boot is taken into account for purposes of Code Sec. 1031(b) only to the extent the boot exceeds the amount of excluded gain.
Rev. Proc. 2005-14 is effective January 27, 2005; however, taxpayers may apply it to taxable years for which the period of limitations on refund or credit under Code Sec. 6511 has not expired.
Courtesy of CCH.COM