7848 / What ownership and use requirements apply if a taxpayer wishes to take advantage of the exclusion for gain on the sale of a principal residence?

In order to claim the full amount of the exclusion, the taxpayer generally must have owned and used the residence as his or her principal residence for an aggregate of two years during the five years prior to the sale or exchange.¹ Additionally, the full amount of the exclusion cannot be claimed if the taxpayer took the exclusion for a prior sale during the two-year period ending on the date of the sale or exchange.² For an explanation of the term “use of” property, see Gummer v. U.S.³

The ownership and use requirements for periods aggregating two years or more may be satisfied by establishing ownership and use for 24 full months or for 730 days (365 × 2). The ownership and use requirements do not have to be satisfied simultaneously so long as both tests are satisfied during the five-year period ending on the date of the sale.⁴ To establish that a taxpayer has satisfied the two-year use requirement, occupancy of the residence is required. However, short temporary absences, such as for vacation or other seasonal absence (although accompanied with rental of the residence), are counted as periods of use.⁵ For example, a one-year sabbatical leave abroad is not considered to be a short temporary absence; on the other hand, a two-month summer vacation does count as a short temporary absence.⁶

Determination of use during period of out-of-residence care. If a taxpayer has become mentally or physically incapable of self-care, and the taxpayer sells or exchanges property that he or she owned and used as a principal residence for periods aggregating at least one year during the five-year period preceding the date of the sale, an exception to the use requirement applies. Such a taxpayer will be treated as using the property as the principal residence for any period of time during the five-year period in which the taxpayer owns the property and resides in any facility (including a nursing home) licensed by a state or a political subdivision to care for an individual in the taxpayer’s condition.⁷

Ownership by trusts. If a residence is held by a trust for a period in which the taxpayer is treated (under the grantor trust rules) as the owner of the trust (or the portion of the trust that includes the residence), the taxpayer will be treated as owning the residence during that period for purposes of satisfying the two-year ownership requirement of IRC Section 121. Accordingly, the sale or exchange of the residence by the trust will be treated as if made by the taxpayer.⁸ The Service has privately ruled that the income beneficiary of a trust, which held her mother’s residence as its only asset, was not considered the owner of the residence because she lacked the power to vest the trust corpus or income in herself; thus, the gain on the home was not excludable under IRC Section 121.⁹