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For a taxpayer who qualifies to exclude gain under Sec. 121(a),
the exclusion does not apply to the portion of the gain from the
sale of the home that is allocated to periods of nonqualified use
under Sec. 121(b)(5)(A).

Loss, as they had since they started rent- of the health issue, also argued that married during the time that either
ing the property in 2010. On Schedule the Weberts could not exclude any of owned the house.
E for all those years, they reported the the gain from the sale of the Mercer For a taxpayer who qualifies to
number of days in the year they rented Island house under the separate ex- exclude gain under Sec. 121(a), the ex-
the Mercer Island house at fair rental clusion provided under Sec. 121(c). clusion does not apply to the portion of
value and the number of days they used According to the IRS, Sec. 121(c) did the gain from the sale of the home that
the property for personal use. They also not apply because the primary reason is allocated to periods of nonqualified
attached to each return a depreciation for the sale was not a change in place use under Sec. 121(b)(5)(A). Under Sec.
and depreciation recapture schedule that of employment, health, or unfore- 121(b)(5)(C)(ii)(III), periods of non-
reported the number of days the house seen circumstances. qualified use do not include a “period of
was rented each year, which matched Sec. 121(a) exclusion: Under Sec. temporary absence (not to exceed an ag-
the fair rental days reported on the 121(a), a taxpayer can exclude the gain gregate period of 2 years) due to change
Schedules E. on the sale of a house if the taxpayer has of employment, health conditions, or . . .
The IRS examined their 2015 return, owned and used the house as a principal other unforeseen circumstances.”
issued a separate notice of deficiency to residence for at least two of the five Sec. 121(c) exclusion: A taxpayer
each of the now-divorced Weberts, and years immediately preceding the sale. who does not qualify for a Sec. 121(a)
disallowed the Sec. 121 exclusion of in- The term “principal residence” means exclusion because he or she does not
come from the sale of the Mercer Island “the chief or primary place where a meet the ownership or use requirement
home. The Weberts took the dispute to person lives or . . . the dwelling in which may still be allowed a reduced exclusion
Tax Court. a person resides” (Gates, 135 T.C. 1, 7 under Sec. 121(c), if the “sale or
The IRS filed a motion for partial (2010) (emphasis omitted)). Whether exchange is by reason of a change in
summary judgment in the case. It con- a house is the taxpayer’s principal place of employment, health, or, to
tended that there was no genuine dis- residence depends on all the facts and the extent provided in regulations,
pute of material fact regarding whether circumstances. unforeseen circumstances.” Unless one
the couple could exclude the gain from The maximum exclusion of gain of the safe harbors in Regs. Sec. 1.121-3
the sale of the Mercer Island house be- under Sec. 121(a) from the sale of a applies, this standard only applies if the
cause they failed to use it as their prin- principal residence is limited under Sec. primary reason for the sale or exchange
cipal residence for the requisite period 121(b)(1) to $250,000 for an individual is one of these three reasons.
under Sec. 121(a). or under Sec. 121(b)(2) to $500,000 The Sec. 121(c) exclusion has its
Steven and Catherine responded for married taxpayers filing jointly. To own limitation: The amount of the
separately to the IRS’s motion. Cath- take the $500,000 exclusion, among exclusion that might otherwise have
erine did not oppose the IRS’s motion, other things, one spouse of the couple been permitted for an exclusion under
but Steven did. In his response, he must meet the two-year ownership Sec. 121(a) ($250,000 or $500,000) is
asserted (but not in the form of an af- requirement for the house, and both multiplied by a fraction, the numera-
fidavit or declaration) that he and Cath- spouses must meet the use requirement. tor of which is the aggregate periods,
erine did use the Mercer Island house However, under Sec. 121(b)(2)(B), if during the five-year period ending on
as a residence and that the reasons for the spouses do not collectively meet the the date of such sale or exchange, such
the sale included Catherine’s health ownership and use requirements, the property has been owned and used by
problems. excludable gain under Sec. 121 is the the taxpayer as the taxpayer’s principal
In its reply to Steven’s response, total of the gain that each spouse would residence and the denominator of
the IRS, reacting to Steven’s raising be allowed to exclude if they were not which is two years (or 730 days or 24

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