A reduced exclusion applies to any sale or exchange if a taxpayer doesn’t meet the ownership, use or once-every-two-years requirements due to a change in the place of employment, health or (to the extent provided in regs) unforeseen circumstances. The reduced exclusion applies if any of the following are true:
(1) Taxpayer did not meet the ownership and use tests for a home sold due to a change in health, place of employment or unforeseen circumstances (as defined in regulations), or
(2) Exclusion would have been disallowed because taxpayer sold more than one home during the two-year period, except if the taxpayer sold the home due to a change in health, place of employment or regulations-defined unforeseen circumstances.
Change in Employment - is a change in the location of the employment (including self-employment) of a qualified individual (taxpayer, spouse, co-owner of the residence, or a person whose principal place of abode is in the same household as the taxpayer). This condition is treated as met (a safe harbor, Reg. Sec. 1.121-3(c)) if:
(1) The new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment (for the unemployed, 50 miles between the new place of employment and the residence sold or exchanged); and
(2) The change in place of employment occurs during the period of the taxpayer's ownership and use of the home as his principal residence.
The Health Condition - is met if the primary reason for the sale is:
(1) To obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or
(2) To obtain or provide medical or personal care for a qualified individual suffering from a disease, illness, or injury.
A qualified individual is:
- The taxpayer,
- The taxpayer’s spouse,
- Co-owner of the residence,
- A person whose principal place of abode is in the same household as the taxpayer,
- The taxpayer's family members listed in Code Sec. 152(a)(1) through Code Sec. 152(a)(8) (generally the same as the relationship test for dependency), even if they aren't his dependents, or
- Descendants of the taxpayer's grandparent (e.g., first cousins).
A sale or exchange doesn't qualify for the health condition if it is merely beneficial to the general health or well-being of the individual. The health condition is treated as met if a doctor recommends a change of residence for the health reasons listed above in (1) and (2). (Reg. § 1.121-3(d))
Strategies - The definition of a “qualified individual” opens up some interesting possibilities and, although we cannot cover all of them, the following are some examples:
Incapacitated Parent – Suppose an elderly parent for health reasons can no longer care for themselves. A child, or other qualified relative, could sell their home and use the partial exclusion in order to relocate closer to an elderly parent or vice versa.
Joint Owners – Suppose two unrelated individuals buy a home together. Things don’t work out and one loses a job, etc., while the other relocates and changes jobs (meeting the 50-mile requirement). Because the co-owner is a qualified individual, the owner that did not relocate can still utilize the partial exclusion.