Exceptions to the Two-Year Requirements

Exceptions to the Two-Year Requirements

The Exceptions to the Two-Year Requirements Because the general rule requiring a taxpayer to have owned and lived in a home for two of the last five years is firm but not set in stone, exceptions to the rule do exist. Likewise, there are exceptions to the rule that you not take the primary residence exemption more than once in any two-year period. The regulations provide an exception if you did not meet the ownership and use tests or your exclusion would have been disallowed because you sold more than one home in a twoyear period if you are selling your home as a result of the following:

1 A change in your place of employment
2 Your health
3 Unforeseen circumstances “to the extent provided in the regulations”

The first of these three exceptions a change in your place of employment is the most commonly used, and its meaning seems clear.

Example:
Ted and Tish bought their current home about one year ago. They sold their previous home one year ago and used their primary home exemption on that sale. Ted works for a large international corporation and has just been notified that he is being transferred to another state. Ted and Tish’s current home will not qualify for a primary
residence exemption because they have not met the two-year ownership or use test. In addition, even if they could otherwise meet the ownership and use tests, they would be disqualified from taking the exemption because they have used their exemption on the sale of another property less than two years ago. However, by applying the change-in-the-place-of-employment exception, Ted and Tish will be able to take a reduced exemption.

The employment change does not have to be an involuntary transfer or even one with the same company. In the above example, if Ted had simply decided to take a better job in a different area of the country, the exemption would still apply. If the change in place of employment involves a considerable distance, there is usually no question that the exception can be used.

The more difficult question arises when the change is close geographically. At the time of this writing, the IRS offers little guidance, so check with your tax advisor for any recent clarifications. The health exception is more ambiguous. The regulations don’t specify which health conditions qualify, so the exception may be a matter
of opinion, and the IRS’s opinion controls.

Obviously, if an illness is well documented in your medical records and your physician writes a supporting letter stating that the change is necessary, your chances of being disallowed on an audit are lessened. However, if you are trying to use this exception because you feel the change will do you good, you are likely to get resistance from the IRS. The best approach is to have good documentation supporting the move as the result of a verifiable medical condition.

The last exception—unforeseen circumstances—sounds like a fitall loophole. After all, just about anything that makes a person want to move twice in less than two years is arguably an unforeseen circumstance. In practice, however, this exception is useless because it applies only to unforeseen changes “to the extent provided in the regulations.” The problem is that currently there are no unforeseen circumstances Using the Primary Residence Exclusion 37

Example:
Ted and Tish bought their current home about one year ago. They sold their previous home one year ago and used their primary home exemption on that sale. Ted works for a large international corporation and has just been notified that he is being transferred to another state. Ted and Tish’s current home will not qualify for a primary
residence exemption because they have not met the two-year ownership or use test. In addition, even if they could otherwise meet the ownership and use tests, they would be disqualified from taking the exemption because they have used their exemption on the sale of another property less than two years ago. However, by applying the change-in-the-place-of-employment exception, Ted and Tish will be able to take a reduced exemption. provided in the regulations. Even IRS Publication 523, Selling Your Home, goes on to say after telling you that this exception exists:

The IRS has not issued regulations defining unforeseen circumstances. You cannot claim an exclusion based on unforeseen circumstances until the IRS issues final regulations or other appropriate guidance.

Much effort has been made by the accounting community to persuade the IRS to issue regulations explaining what is meant by unforeseen circumstances. Some suggestions of what should be allowed include sales resulting from divorce, job loss, health conditions of a nonowner family member, environmental problems, safety issues, and the death of a family member. But despite all the efforts, it is unlikely that the IRS will rush to issue regulations clarifying, or creating a use for, the unforeseen
circumstances exception anytime soon.