Arrival of Second Child Qualified as Unforeseen Circumstance for §121(c) Reduced Exclusion for Gain on Sale

The taxpayers in PLR 201628002 were asking for the ability to use the reduced exclusion of a gain from the sale of principal residence under IRC §121(c)(2)(B)’s “unforeseen circumstance” provision due to the birth of a second child.

IRC §121 provides that taxpayers may exclude up to $250,000 ($500,000 for married taxpayers filing a joint return) of gain on the sale of a home if the property was owned by them for at least 2 of the past 5 years and also was used by them for 2 of the past 5 years (though the periods do not necessarily have to be the same days). The “2 of the last 5 years” test are applied as of the date of the sale. The provision also limits a taxpayer generally to claiming the exclusion only once every two years. [IRC §121(b)]

Recognizing that sometimes taxpayers are put in unexpected situations that force a sale, Congress provided that taxpayers who fail to meet the above rules may nevertheless qualify for some exclusion if the sale is caused by “by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances.” [IRC §121(c)(2)(B)] .

The related regulations note:

A sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer could not reasonably have anticipated before purchasing and occupying the residence. [Reg. §1.121-3(e)(1)]

As well the regulations provide that “primary reason” test shall by applied by looking at all facts and circumstances. [Reg. §1.121-3(b)]

In this case the facts are fairly simple, as provided in the ruling:

Taxpayers were married and had one child (a daughter) when they purchased Residence 1 on Date 1. Residence 1, a condominium, had two small bedrooms and two baths. The child's bedroom also served as the Husband's home office as well as a guest room. After the purchase of Residence 1, Wife became pregnant and gave birth to another child (a son). On Date 2, Taxpayers moved out of Residence 1, and on Date 3, Taxpayers sold Residence 1.

The taxpayers were asking to use the reduced exclusion to offset their gain on the sale of Residence 1.

The IRS determined that, given the facts cited above (which, as you’ll note, was the problem the were running out of rooms) the pregnancy qualified as an unforeseen circumstance and that it was the primary reason for their sale before meeting the various two year tests.