8677 / If a taxpayer has multiple residences, which residence qualifies as the principal residence in determining whether exclusion of gain upon sale is permissible?

Whether or not a residence is considered the taxpayer’s principal residence for purposes of the Section 121 exclusion requires a traditional facts and circumstances analysis.¹ Assuming that the taxpayer alternates between two or more residences, the residence in which the taxpayer resides for the majority of the time generally will be considered the principal residence. Additionally, other factors are considered in making the determination, including the following non-exhaustive list:

(1)  the taxpayer’s place of employment;

(2)  the principal place of residence of the taxpayer’s family members;

(3)  the address listed by the taxpayer on his or her driver’s license, tax returns, car registration and voter registration card;

(4)  the taxpayer’s mailing address for bills and correspondence;

(5)  the location of the taxpayer’s bank; and

(6)  the location of religious organizations and recreational clubs with which the taxpayer is affiliated.²

In a case involving two different residences that were located in different states, the Tax Court held that the taxpayer’s principal residence was the one in which the taxpayer spent a substantial amount of time (i.e., threw family parties and celebrated holidays) even though the second residence address appeared on the taxpayer’s tax returns over the years. In addition, the Tax Court rejected the IRS’ contention that the second residence was the taxpayer’s principal residence because the taxpayer (1) owned a business in that state and (2) held a liquor license that required state residency.³

With respect to multiple residences, it is possible that over a five-year period, a taxpayer may not spend the majority of days in any one residence for the two required years. Thus, he or she would not be able to take advantage of the exclusion due to the failure to meet the two-year use requirement (see Q 8674).

Example: In the past five years, Jim and Nancy alternated between homes in Michigan, Florida and New York. During that five-year period, they spent more time in the Florida residence than in any other home. However, within that period, there was only one year in which they spent the majority of days in Florida. Therefore, even though their principal residence is in Florida, they will be unable to exclude gain on its sale under Section 121 because they will be unable to satisfy the two-year use requirement.⁴

Although not expressly addressed in the regulations, if the taxpayers were able to satisfy the two-year use requirement for more than one residence during the relevant five-year period, they should be able to exclude gain from the sale of either residence (but not both residences).

Example: During the previous five-year period, Jim and Nancy spend the majority of their days in Florida during years one and two. In years three and five, they spend the majority of their days in Michigan. If they choose to sell either of the Florida or Michigan residences, they will have satisfied the two-year use requirement for both residences and, assuming the other requirements are met, they should be able to exclude the gain on the sale of either residence as their principal residence.