By Tom Herman, The Wall Street Journal Online
RISMEDIA, July 30, 2007—Being a crime victim is usually no cause for celebration. But there is at least one consolation: The IRS may give you a tax break when you sell your home.
Most people who sell their home after having owned it for at least two years don’t have to pay federal taxes on their gain. A sale in less than two years after the purchase, however, often triggers some sort of tax hit. But even owners who need to sell in less than two years may qualify for special relief if they had to sell because of “unforeseen circumstances,” according to a 1997 law.
While those words can be hard to define, a recent survey of Internal Revenue Service rulings indicates the agency generally has been “very sympathetic” to taxpayers in cases of unexpected distress — such as crime victims — says Gail Levin Richmond, a law professor at Nova Southeastern University Law Center in Davie, Fla.
Looking for ways to protect gains from home sales may seem counterintuitive in view of the current housing slump. But while prices generally have flattened or fallen in many parts of the country in recent months, home values in many markets are still significantly higher than they were two years earlier. Sellers may still be able to reap handsome short-term gains, even if their home doesn’t fetch the price they once had dreamed about, says David Stiff, chief economist at Fiserv Lending Solutions in Cambridge, Mass., a unit of Fiserv Inc.
The general rule is that you can exclude a gain of as much as $500,000 if filing a joint return with your spouse, or as much as $250,000 if single or filing separately, under certain circumstances. To be eligible for this full exclusion, you typically must have owned your home, and lived in it as your primary residence, for at least two of the five years prior to the sale. This rule applies only to your main residence, not a vacation home.
Even if you can’t meet the two-year tests, you still may be eligible for a reduced exclusion if you had to sell because of “a change in place of employment,” health reasons or those “unforeseen circumstances.” An IRS publication offers a general definition of unforeseen circumstances as “the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home.”
But how does the IRS react when presented with specific taxpayer queries? In the latest issue of a quarterly publication of the American Bar Association tax section, Ms. Richmond summarizes 10 so-called private-letter rulings since 2004 in which the IRS agreed that taxpayers had sold in less than two years because of “unforeseen circumstances.” (The IRS rulings don’t identify any of the taxpayers or give dollar amounts.)
Technically, a private-letter ruling applies only to the taxpayer who requested it and isn’t supposed to be used or cited as precedent. But such rulings are considered important anyway by lawyers and accountants because they offer a window into the IRS’s thinking.
In one ruling, a taxpayer had to provide a separate bedroom in order to adopt an orphan child from another country. In another ruling, released recently, marriage was the issue. Taxpayers A and B each had purchased a home. Later, they met, got married and bought a new, larger home for their blended family. They each sold their prior homes. Taxpayer B had owned it less than two years. The IRS said the occurrence of the marriage and the need to “suitably accommodate their blended family” represented “unforeseen circumstances.”
Crime victims often win the IRS’s sympathy. In one case, a taxpayer was leaving home when an assailant held a gun to the taxpayer’s head and forced the taxpayer into the taxpayer’s car. “The assailant was agitated, unpredictable, and made repeated threats” on the taxpayer’s life, the IRS said in the ruling. For about an hour, the taxpayer was forced, at gunpoint, to drive the assailant to several locations, including an ATM, and withdraw money for the crook. The IRS concluded that the taxpayer’s main reason for selling that home was an unforeseen circumstance.
In another case, two taxpayers moved from one state to another, bought a home and then became aware of “various criminal activities” in their new neighborhood. Their son was assaulted and threatened, and one of the taxpayers was assaulted by several neighbors, resulting in a trip to the hospital emergency room. Because of the assault and general nature of the neighborhood, the two taxpayers sold their home and bought a new one. The IRS agreed the “primary reason” for the sale was an unforeseen circumstance.
Calculating the reduced maximum exclusion can often be tricky. Here’s a simple example: Suppose you and your spouse sold your home at a $10,000 profit after having owned and lived in it for only one year. You sold because of a move from New York to California to take a new job, or some other unforeseen circumstance. Since the exclusion amount is pro-rated, you typically would qualify for half the maximum exclusion (since you had owned the home for half of the two-year period) and thus would be able to exclude your entire $10,000 gain.