IRC §121 provides a taxpayer the opportunity to exclude up to $250,000 ($500,000 if married filing jointly) of gain from the sale of a principal residence. For the taxpayer to claim the exclusion, both the use and time tests must be satisfied: The residence sold must have been the taxpayer’s principal residence (use) for two out of the last five years (time).

For those who don’t satisfy the time test, there’s also a partial exclusion provided by §121(c)(2)(B) if the sale resulted from a change in place of employment, health reason, or an unforeseen circumstance. The partial exclusion (also known as the reduced maximum exclusion) rules are found in Reg. §1.121-3, which provides safe harbor rules to rely on. The taxpayer also may use a fact and circumstance defense for situations not covered under the safe harbor rules.


A taxpayer can qualify for the partial exclusion if he or she relocates as a result of changing employers, moving to another facility of the current employer, or the commencement/continuation of self-employment. To satisfy this safe harbor, the distance between the taxpayer’s new place of employment and the residence sold must be at least 50 miles greater than the distance between the taxpayer’s former place of employment and the residence sold. If the taxpayer was previously unemployed, he or she may still qualify for the partial exclusion if the distance between the qualified individual’s new place of employment and the residence sold or exchanged is at least 50 miles [Reg. §1.121-3(c)].


A taxpayer can qualify under this criterion if the move is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, which includes the taxpayer, a spouse, co-owner of the residence, or someone else who lives in the residence as the principal place of abode [Reg. §1.121-3(d) and §1.121-3(f)].

A physician’s recommendation for such a move is needed to support the taxpayer in this situation. It can be documented by a letter. A move that’s merely beneficial to the general health or well-being of an individual doesn’t qualify.


The third category is a catch-all category covering situations that couldn’t have been anticipated before the taxpayer bought the residence. Reg. §1.121-3(e) provides a list of specific safe harbor events that fall under this category. Unforeseen circumstances include involuntary conversions, natural or manmade disasters (including acts of terrorism), death, loss of employment in which the qualified individual is eligible for unemployment compensation, change in employment or self-employment status resulting in the taxpayer’s inability to pay housing costs and reasonable basic living expenses, divorce or legal separation, or multiple births resulting from the same pregnancy. Although this list is fairly exhaustive, the regulations do provide the Commissioner the right to designate other events or situations that fall under this category.

The Commissioner has issued a few rulings for unforeseen circumstances. Recently, a favorable ruling (PL Rul. 201628002) was issued to a couple who sold their two-bedroom condominium after having a second child. The couple had a daughter when they purchased the condominium and utilized that child’s bedroom as the husband’s office as well as a guest bedroom. After moving into the residence, the wife learned she was pregnant and gave birth to a son, which made the condominium inadequate for the couple, and they sold the unit. Due to the facts and circumstances, the Commissioner issued a favorable ruling.

A favorable ruling also was issued in PL Rul. 200725018, which pertained to a blended family situation and the sale of the spouses’ respective residences. In this case, the spouses owned a three-bedroom house together. One spouse had three children from a previous marriage, and the other had two children from a previous marriage. As a result of their recent marriage, the couple elected to purchase a four-bedroom house to accommodate the blended family. But one spouse didn’t meet the time test and wasn’t entitled to the full exclusion. The other spouse did, however, so the ruling only applied to that spouse who did qualify.

Reg. §1.121-3(c), (d), and (e) provide examples illustrating situations that do or do not qualify for the partial gain exclusion.


The partial exclusion is in essence a reduction of the maximum exclusion. It’s computed by multiplying the maximum dollar exclusion of $250,000 (or $500,000 for married filing jointly) by the fraction of time for ownership. That is, the numerator is the number of days or months that the taxpayer owned the unit, and the denominator is either 730 days or 24 months (depending on the measure of time used in the numerator). Reg. §1.121-3(g) provides two examples that address a single taxpayer situation and a married taxpayer situation whereby one spouse doesn’t meet the time test.

Example 1. Alice purchases a house that she uses as her principal residence. Twelve months after the purchase, she sells the house due to a change in her place of employment. Alice hasn’t excluded gain under §121 on a prior sale or exchange of property within the last two years, so she’s eligible to exclude up to $125,000 of the gain from the sale of the house (12/24 × $250,000).

Example 2. Harry owns a house that he has used as his principal residence since 1996. On January 15, 1999, he marries Wendy, who begins to use Harry’s house as her principal residence. On January 15, 2000, Harry sells the house due to a change in Wendy’s place of employment. Neither has excluded gain under §121 on a prior sale or exchange of property within the last two years.

Because both Harry and Wendy haven’t used the house as their principal residence for at least two years during the five-year period preceding its sale, the maximum dollar limitation amount that they may claim together won’t be $500,000. Rather, it’s the sum of each spouse’s limitation amount determined on a separate basis as if they hadn’t been married. (See Reg. § 1.121-2(a)(3)(ii).)

Harry is eligible to exclude up to $250,000 of gain because he meets the two-year time requirement. Wendy doesn’t meet the two-year time requirement, so she is ineligible to exclude the maximum dollar amount. Because the sale is due to a change in place of employment, Wendy is eligible to claim a partial exclusion of up to $125,000 of the gain (365/730 × $250,000). Together, the couple therefore is eligible to exclude up to $375,000 of gain ($250,000 + $125,000) from the sale of the house.

Although the partial exclusion regulations appear straightforward, it’s important to keep good documentation on the dates of ownership and details on the reasons for moving to satisfy the time test. Moreover, this partial exclusion can be easily missed, so taxpayers need to be keenly aware of the opportunity.

© 2016 A.P. Curatola

About the Authors