Section 121 Exclusion

[annb]

Facts:  Son, mother and father are all owners in a home.  The son lives in the home, but the parents do not.  The son wants to sell the home.

Question:  If the parent's gift their 2/3 ownership to the son and then the son sells the home - can the son use the entire Sec 121 exclusion based on his filing status??

Thank you in advance!

A Borges

[qbteachmt]

There's an ownership component and a usage component. Does he intend to live there long enough to meet the ownership requirement?

[taxmo · Accepted solution]

Only if he waits two years after the date they gift their 2/3 portion to him. 

The way it works is when there are joint owners, each owner can qualify to exclude $250,000 from their portion of the gains on sale if they meet all the qualifications.  So as it is, he would qualify to deduct $250k from his gains, but the parents would not.

They can't just gift their interest in the property to him and have him qualify right away to deduct the gains from the whole property, because that portion of the property wouldn't yet meet the 2 year requirement.  

[annb]

Thank you for your promptness in answering my question. 

[TaxGuyBill]

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@taxmo wrote:

Only if he waits two years after the date they gift their 2/3 portion to him.

They can't just gift their interest in the property to him and have him qualify right away to deduct the gains from the whole property, because that portion of the property wouldn't yet meet the 2 year requirement.  

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Do you have a citation for that?

I would need to look things up again, but in many cases an owner is still entitled to use 100% of the property even when it is owned by more than one person. 

While I agree that your comment seems somewhat 'fair', I don't think it is necessarily correct (although it is possible how the title was held and state law could affect it).

[taxmo]

§ 1.121-2(a)(2) is primarily what I was basing that on, which allows each joint owner to exclude gain "that is attributable to each taxpayer's interest in the property". 

Depending on the state, they may have a tenancy in common and a joint tenancy.  Either way, each person has an "undivided interest" in the property, which means they all have a right to use any part of the property.  But they do still only own a partial interest in the property (a partial ownership percentage).  

So my thought process is that as co-owners who are entitled to 100% use of the property, they pass the would pass the "use test" for the whole property.  But I don't think they would pass the "ownership test" for 2 years for 100% of the property, only their partial interest portion.  

I couldn't find specific tax court cases or other references to this specific situation, so it's possible there is a different way this is supposed to be handled. 

[qbteachmt]

That's why I asked the question if he would stay long enough to meet the ownership test for the newly-owned portion. He occupied the house but didn't own 100% of it.

As it is now, he can exclude up to $250,000 of his 1/3 share of the sale gain. The parents are not primary residents, only owners.

If they gift their share(s), we know that passes with their basis. That doesn't make him a 100% owner for purposes of the 2-year ownership component. That only changes the math = who reports the 2/3 gain. Now he reports all the gain and still has the same exclusion limit based on his 1/3. If the total gain is $300,000 he only excludes $100,000 before the gift or after the gift.

I found this analysis:

https://www.exeterco.com/pdfs/Multiple_Taxpayers_Exclude_Capital_Gain_under_Section_121.pdf

And this topic:

https://www.irs.gov/taxtopics/tc701

"You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale."

He can be gifted or buy them out, but he's not 100% owner until 2 more years have passed. He qualifies for the exclusion then, even if he moves out now.

[TaxGuyBill]

Interesting.  Maybe it varies by state.

In my State (Minnesota), from what I've researched "Joint Tenancy" (which is by far the most common form of ownership that I've seen), each party is considered as owning 100%.  Yes, owning 100% (not just the right to use 100%).

But maybe other states are different.

[sjrcpa]

I don't know how it applies to the 121  ownership period for the exclusion, but otherwise, the holding period for a gift tacks.

[qbteachmt]

"the holding period for a gift tacks."

Oh, ding ding ding! There's the final piece of the puzzle. Certainly true for determining short or long term, and of course that applies to gain from gifted real estate. So, basis and ownership will transfer, and since he also already lived there 2 of 5 years, he wouldn't even need to also be a current owner for the exclusion to be the full $250,000. Interesting.

[taxmo]

Yes, the "holding period" transfers under § 1223(2), which makes it eligible for long-term rather than short-term capital gains, but my understanding is that doesn't apply to the § 121 ownership requirement.  

In response to TaxGuyBill's last reply, I don't think we know what type of co-ownership they have in this particular situation, and even if we did, it sounds like we both aren't 100% certain about how that impact the § 121 treatment anyway.  I think my understanding of it is probably correct, but it is possible that one or more of the types of co-ownership actually means they qualify.  It's also possible there isn't a definitive answer to this if there haven't been any tax court cases, PLRs, etc. on this.  But if they don't take the exclusion on the gifted portion, that would be the more conservative approach at least, but not as beneficial.