Tax Implications of Home Ownership (Portfolio 594)

Tax Management Portfolio, Tax Implications of Home Ownership, No. 594-3rd, discusses the tax consequences of the purchase, financing, refinancing and sale or exchange of a taxpayer's principal residence.

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Tax Management Portfolio, Tax Implications of Home Ownership, No. 594-3rd, discusses the tax consequences of the purchase, financing, refinancing and sale or exchange of a taxpayer's principal residence.
Section 121 provides that taxpayers may exclude from income up to $250,000 ($500,000 for taxpayers filing joint returns) of gain from the sale of a residence. The residence must have been owned and used by the taxpayer as his or her principal residence for periods aggregating two years during the five-year period preceding the sale. The exclusion is allowed each time a taxpayer meets the eligibility requirements, but generally no more frequently than once every two years.
Section 217 permits a deduction of certain moving expenses. The Revenue Reconciliation Act of 1993 narrowed the scope of the moving expense deduction under §217, but provided a significant benefit by making the deduction an above-the-line item, to be taken into account in determining adjusted gross income. In addition, the 1993 Act amended §§82 and 132, so that employer reimbursements of moving expenses are generally excludible from income.
Section 163(h) excepts from the disallowance of personal interest deductions any qualified residence interest paid or accrued by a taxpayer. Qualified residence interest includes “acquisition indebtedness” (i.e., debt secured by the taxpayer's residence that is incurred to acquire, construct, or substantially improve that residence), and “home equity indebtedness” (i.e., debt secured by the residence that does not exceed the fair market value of the residence less any acquisition indebtedness, but limited to $100,000).


Bruce N. Edwards

Bruce N. Edwards, B.A., The Colorado College; J.D., University of Washington School of Law; LL.M. (in Taxation), New York University; former Law Clerk to the Honorable Shiro Kashiwa, Associate Judge, the United States Court of Claims (now the Court of Appeals for the Federal Circuit); member, Washington, Alaska, U.S. Tax Court, Court of Federal Claims, U.S. Supreme Court, U.S. Courts of Appeals (Ninth, D.C. and Federal Circuit), U.S. Customs Court Bars; former New Decisions Editor, The Journal of Taxation; repeatedly selected as Superlawyer, Washington Law & Politics; author, TPS ¶ 1510 Like-Kind Exchanges; TPS ¶ 3880 Tax Court Litigation; TPS ¶ 3890, Refund Litigation; TPS ¶ 1520, Involuntary Conversions; TPS ¶ 2650, Timber Transactions; 568 T.M., Involuntary Conversions; 610 T.M., Timber Transactions; “Understanding and Using ‘Partnership Redemptions' In the Context of Section 1(h),” 45 Tax Mgmt. Memo. No. 19, 1 (September 20, 2004); TPS ¶ 1530, Home Ownership; “Understanding And Making The New Section 646 Election For Alaska Native Settlement Trusts,” 18 Alaska Law Journal 217 (Duke University 2001); TPS ¶ 3850 IRS Audit Procedures; TPS ¶ 3860, Statute of Limitations; member American College of Tax Counsel.

Table of Contents

Detailed Analysis

I. Overview

II. Purchase, Improvement and Financing

A. Basis

1. In General

2. Items Included in Basis

3. Capital Additions and Other Increases to Basis Following Acquisition

a. Through Additional Expenditures

b. Operation of the Tax Law

4. Reductions to Basis

a. Casualty Losses

b. Involuntary Conversions

c. Pre-May 1997 Law - Gain Rollovers Under Former § 1034

d. Depreciation

B. Taxes and Similar Assessments

1. Property Taxes

2. Sales Taxes

3. Other Assessments

C. Date of Transaction

1. In General

2. Examples from Case Law

a. Baertschi

b. Poague

c. Comment

3. Ownership of Escrow Prior to Closing

D. Tax Issues Related to Purchasing/Financing/Refinancing

1. Deductibility of Interest

2. Qualified Residence Interest

a. In General

b. Interest on Home Equity and Acquisition Indebtedness

c. Qualified Residence

d. Debt Secured by Residence

e. Tax-Exempt Housing Allowance

f. Pre-October 13, 1987 Indebtedness

g. Mortgage Insurance Premiums

h. Cooperative Housing Corporations

i. Estates and Trusts

j. Alternative Minimum Tax

3. Points (Prepaid Interest) and Other Charges

a. Points

(1) Revenue Procedure 94-27 Safe Harbor

(2) Outside the Rev. Proc. 94-27 Safe Harbor

(a) General

(b) Refinancing

(c) Payment From Taxpayer's Separate Funds

(d) Capitalized Points

b. Other Charges

4. Home Mortgage Interest and First-Time Homebuyer Credits

5. Reporting by Mortgagees - Information Returns

a. In General

b. Points

c. Reimbursements of Mortgage Interest Overpayments

d. Cancellation of Indebtedness

6. Qualified Principal Residence Indebtedness

III. Moving to the New Residence

A. Moving Expenses and Reimbursements - Introduction

B. Tax Treatment of Job-Related Moving Expenses

1. Overview

2. Whose Expenses Are Deductible?

a. Employees and Self-Employed Individuals

b. Members of Taxpayer's Household

3. "Moving Expenses" Defined

4. Commencement of Work at New Principal Place of Work

5. Distance and Duration-of-Employment Conditions

a. The Minimum Distance Requirement

b. The Minimum Duration-of-Employment Requirement

6. Taxability of Reimbursements

C. Tax Treatment of Employers

1. Deductibility of Reimbursements

2. Withholding on Reimbursements

3. Reporting of Reimbursements

D. Special Situations

1. Foreign Moves

a. Deductions

b. Exclusions

c. Retirees and Survivors

2. Military Moves

3. Employer Provided "Bargain Loans" to Facilitate Relocations

E. Timing of Reimbursements and Deductions

F. Alternative Minimum Tax Considerations

IV. Sales - Exclusion of Gain on Sale of Residence: Current Law - Post-1997 Taxpayer Relief Act § 121

A. Introduction

1. Overview of Current Provision

2. Section 121: In General

B. Limitations

1. In General

2. Joint Returns

3. Disposition Caused by Employment, Health, or Unforeseen Circumstances

4. Exclusion of Gain Allocated to Nonqualified Use

C. Determination of Period of Ownership and Use

1. "Use" When Out-of-Residence Care

2. Ownership and Use in Context of Home of Deceased Spouse

3. Property Owned by Spouse or Former Spouse

4. Homes Acquired in Former § 1034 Rollovers

5. Involuntary Conversions

6. Use by Bankruptcy Estate

7. Use by Trust

8. Use by Former Partnership

9. Election to Suspend Period

10. Use by Tenant-Stockholder in Cooperative Housing Corporations

11. Ownership by Certain Single Owner Entities

12. Property Acquired in Like-Kind Exchange

D. Concept of Use of Principal Residence

1. In General

2. Alternating Use of Residences

3. Inclusion of Vacant Land as a Part of Principal Residence

E. Sale of Principal Residence Partially Used for Business Purposes

F. Recapture of Federally Subsidized Mortgages

G. Sales of Partial Interests

H. Expatriates and Aliens

I. Effective Date and Transition Provisions

J. Tax Reporting

K. Special Audit Protection

L. Retroactive Application

M. Interrelationship of § § 121 and 1031

N. Interrelationship of § § 121 and 453

V. Sales - Exclusions of Gain on Sale of Residence - Former Law: § 1034 Gain Rollovers

A. In General

B. Gain Rollovers Under Former § 1034

1. Concept of "Taxpayer"

2. Purchase for Another Taxpayer

C. Concept of "Principal Residence"

1. Physical Occupancy

a. Old Residence

b. New Residence

2. Multiple Residences

a. Split Occupancy

b. Summer or Weekend House

3. New Residence Sold Before Old Residence

4. Series of Purchases or Sales

5. Job-Related Move Exceptions

6. Old Residence Vacated or Rented Out Prior to Sale

7. Furniture

D. Houseboat or Trailer

E. Cooperative or Condominium

F. Investment in Retirement Home

G. Foreign Residence

H. Land Sold Without House

I. Multiple Use Property

J. Split Interests

K. Improvements to the New Residence

1. In General

2. Time for Replacement and Physical Occupation

a. Purchase of New Residence

b. Repurchase of Old Residence

c. Construction of New Residence

d. Reconstruction of Another Owned Residence

3. Expiration of Replacement Time

L. Determination of Recognized Gain

M. Basis of New Residence

N. Allocation of Gain Where Property Only Partly a New Residence

O. Special Situations

1. Husband and Wife

2. U.S. Armed Forces - Extension of Replacement Period

P. Involuntary Conversion of Old Residence

Q. Related Party Issues

R. Statute of Limitations

S. Reporting: Gain, Loss and Estimated Tax

VI. Sales - Exclusion of Gain on Sale of Residence: Former Law: § 121 - Sale or Exchange of Residence at Age 55 or Older: Prior Law

A. Outline of Former § 121

B. Purpose of Former § 121

C. Comparison of Former § 121 and Former § 1034

D. Effective Dates

E. Concept of Qualifying Taxpayer

1. Co-ownership and Joint Return

a. One Spouse Satisfies All Requirements

b. Determination of Marital Status-Date of Determination

c. Definition of Marital Status

2. Jointly Owned Property

3. Tenant-Stockholder in Cooperative Housing Corporation

4. Trust or Estate as Taxpayer

5. Bankruptcy Estate

6. Other Situations

F. Age Requirements

G. Occupancy and Ownership Requirements Under Pre-1997 Act § 121

1. Time Measurement

2. Temporary Absences

3. Comparison with Former § 1034 Requirements

4. Application of Occupancy and Use Requirements

5. Property of Deceased Spouse Who Satisfied Ownership/Use Requirements

6. Nursing Home

H. Multiple Use Property

I. Split Interests: Life Estate and Future Interests

J. Sale or Exchange

K. Limitations

1. Joint or Separate Return

2. Gain Exceeding $125,000

3. Single-Election Rules

a. Election by Taxpayer

b. Election by Taxpayer's Spouse

c. Additional Election

L. Interaction with Other Code Sections

1. Section 1033

2. Former § 1034

3. Section 1041

4. Section 453

5. Section 1038

M. Election Procedures - General Requirements

1. Time for Election

2. Married Taxpayer

a. Election by Spouse

b. Election for Deceased Spouse

3. Manner of Making Election

a. General Requirements

b. Content of Statement

N. Revocation of Election

1. General Requirements

2. Consent by Spouse to Revocation

3. Required Extension of Statute of Limitations to Make Revocation Effective

VII. Other Considerations in Sale or Exchange of Residence - Deductions; Reacquisitions

A. Depreciation and Maintenance Expenses

1. Vacated Residence Offered Only for Sale

2. Vacated Residence Offered for Rent or Sale

3. Vacated Residence Temporarily Rented, Pending Sale

B. Deduction of Loss on Sale

C. Reacquisition of Principal Residence in Satisfaction of Secured Debt

1. Section 1038 Generally

2. Reacquisition and Resale of Principal Residence

D. Understated Interest

1. Capital Gains v. Interest

2. Gift Loan

3. Employer Provided Loans

VIII. Credits Available to Homeowners

Introductory Material

A. Residential Energy Credits

1. Nonbusiness Energy Property Credit

a. In General

b. Computation of Credit

(1). In General

(2). Limitations

c. Definitions

(1). Qualified Energy Efficiency Improvement

(2). Residential Energy Property Expenditures

d. Allocation of Credit

e. When Expenditure Made

f. Manufacturer's Certification

2. Residential Energy-Efficient Property Credit

a. In General

b. Computation and Definitions

(1). In General

(2). Limitations

(3). Qualified Solar Electric Property Expenditure

(4). Qualified Solar Water Heating Property Expenditure

(5). Qualified Fuel Cell Property Expenditure

(6). Qualified Small Wind Energy Property Expenditure

(7). Qualified Geothermal Heat Pump Property Expenditure

(8). Labor and Installation Costs

c. Allocation of Credit

d. When Expenditure Made

e. Limitation Based on Tax Liability

B. Home Mortgage Interest Credit

1. In General

2. Computation of Credit

a. In General

b. Certificate Credit Rate

(1) In General

(2) Consequence of Failure to Satisfy 25% Requirement

c. Certified Indebtedness Amount

(1) In General

(2) Qualified Home Improvement Loan

(3) Qualified Rehabilitation Loan

(4) Nonqualified Indebtedness

d. Limitations

3. Mortgage Credit Certificate

a. Definition

(1) In General

(2) Qualified Home Improvement

(3) Qualified Rehabilitation

b. Qualified Form

(1) In General

(2) Required Information

c. Period in Effect

d. Public Notice for Issuance

e. Revocation

f. Reissuance

4. Qualified Mortgage Credit Certificate Program

a. In General

b. Program Establishment Requirement

c. Election Requirement

(1) In General

(2) Revocation

(3) State Certification

d. Modified Qualified Mortgage Bond Requirements

(1) In General

(2) Modifications

(3) Residence Requirement

(4) Three-Year Requirement

(5) Purchase Price Requirement

(6) Income Requirement

(7) Targeted Areas Requirement

(8) New Mortgage Requirement

(9) Failure to Satisfy Requirements

e. Impermissible Mortgage Requirement

f. Particular Lender Requirement

g. Transferability Requirement

h. Developer Requirement

i. Permissible Fees Requirement

5. Limitations

a. Excess Credit Rate

b. Related Mortgagees

6. Reporting Requirements

C. First-Time D.C. Homebuyer Credit

1. In General

2. Income Limitation

3. First-Time Homebuyer

4. Special Rules, Basis Adjustments and Reporting

D. First-Time Homebuyer Credit, Including Long-Time Residents

1. In General; Amount of Credit; Credit Eligibility

2. Definitions and Special Rules

3. Limitations

a. Dollar Limitations

b. Modified Adjusted Gross Income Limitation

4. Exceptions

5. Recapture

6. Election to Take Credit in Previous Year

7. Joint Ownership Between Unmarried Taxpayers

8. Claiming the Credit

E. Computational Limitations and Carryovers

1. In General

2. Home Mortgage Interest Credit

3. First-Time D.C. Homebuyer Credit

4. Residential Energy Property Credit

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 [Reserved]

Worksheet 2 H.R. Rep. No. 426, 99th Cong., 1st Sess. 296â€"301 (1986)

Worksheet 3 S. Rep. No. 313, 99th Cong., 2d Sess. 802â€"08 (1986)

Worksheet 4 Conf. Rep., H.R. Rep. No. 841, 99th Cong., 2d Sess. II 151â€"57 (1986)

Worksheet 5 Conf. Rep., H.R. Rep. No. 103-213, 103rd Cong., 1st Sess. 103 (1993)

Worksheet 6 H.R. Conf. Rep. 220, 105th Cong., 1st Sess. 330 (1997)

Worksheet 7 Rev. Proc. 87-15, 1987-1 C.B. 624

Worksheet 8 Rev. Rul. 87â€"22, 1987â€"1 C.B. 146

Worksheet 9 Rev. Proc. 94â€"27, 1994â€"1 C.B. 613

Worksheet 10 Rev. Proc. 2007-12, 2007-4 I.R.B. 354

Worksheet 11 HUD Settlement Statement with Annotations

Worksheet 12 Sample Client Letter: Sale/Exchange of Residence Under § 121 (General Summary)

Worksheet 13 Sample Client Letter: Sale/Exchange of Residence Under § 121 (Ownership and Use Test)

Worksheet 14 Sample Client Letter: Moving Expenses Under § 217

Worksheet 15 Sample Client Letter: First-Time Homebuyer Credit

Worksheet 16 Summary of Personal Energy Conservation Credits

Worksheet 17 Unforeseen Circumstances Qualifying for Fractional Home-Sale Exclusion of Gain Under § 121(c)