Q: My husband and I are planning to retire in Santa Fe. We have been alternating between homes in Tulsa, Oklahoma, and Scottsdale, Arizona. We are what they call “snowbirds” in Arizona and this has meant we spend roughly half our time in Oklahoma and half in Arizona. We have owned the Oklahoma house for 21 years and it was our only residence for most of that time. We bought the Arizona house about seven years ago. We expect to sell both homes and buy what will be our final home in Santa Fe. My question is how to use the $500,000 exclusion for gain from sale of a main home. Both of our current houses meet the IRS 2-of-5 year ownership test. The Tulsa home should have a gain of about $320,000 and the Arizona home may actually exceed the $500,000. We could probably keep one of the homes for two more years if it is possible to qualify both for the tax exclusion. If not we would prefer to claim the exclusion on the Arizona home. We are both over 55 if that matters.
A: The exclusion requires that the property was your “principal” residence for two of the five years before sale. You can have only one “principal” residence at any time.
This $500,000 exclusion was enacted in 1997. It replaced prior rules that either allowed you to defer gain by trading up in value or to exclude gain if you were 55 or older. There is just one rule now and age does not affect eligibility.
You suggest that you have used the two homes roughly equally over the past five years. If you sell both now only one can be the principal residence qualifying for the gain exclusion.
If you can claim the Arizona property as a principal residence, that also means the Tulsa property was not. So to claim the exclusion twice you would have to occupy the Tulsa property as a principal residence for at least two years before sale.
I am assuming your description of use is accurate. In the right circumstances, someone could have one property qualify as a principal residence for two years and then another property for the next two years. Both could then be eligible for the exclusion.
There is a separate rule that the exclusion may only be claimed once every two years. Even if both properties could qualify, selling both at the same time will not lead to two exclusions.
When this exclusion was created in 1997 the legislative history made it clear that the definition of a “principal” residence had not changed from prior law. Prior law said it was based on facts and circumstances.
The regulations provide more guidance. First, for someone who alternates between two houses during a year, the house where they spend a majority of their time for that year is ordinarily the principal residence.
This definition has been criticized because there are court cases where one property may be the principal residence for five months and the other for seven months, all within the same year. The regulation implies there is one principal residence determined year-by-year.
To be fair, the regulation does say majority of time is “ordinarily” how one determines principal residence status. The regulation also lists other factors to consider.
Relevant factors include place of employment, where family members live, the address used for federal and state tax returns, the state where you maintain a driver’s license and register your cars, and where your voter registration is.
Other factors include the mailing address for correspondence, the location of banks (perhaps less significant with interstate banking), and the location of religious or recreational organizations with which you are affiliated.
I am asked this question every couple of years and I often tell clients that the factors are similar to what a university would use to determine if you qualify for in-state tuition. My point is simply to suggest the factors are fairly standard and logical.
If you sell both homes this year, use the factors above to determine, as best you can, which qualifies for the exclusion. Even if you are challenged you will win on one of the sales.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.
