Monday, September 21, 2015

Principal Residence Sale Exclusion Lost When Taxpayer Reacquires Residence Sold on Installment Basis

By Ralph Z. Levy, Jr.

In a recent Eighth Circuit Court of Appeals decision, the court upheld a finding by the Tax Court that when a taxpayer who sold his principal residence on an installment basis and did not resell the residence within one year after its reacquisition on default by the buyer of the installment financing arrangement could not continue and exclude from income the $500,000 in previously excluded gain on sale of the residence under the principal-residence exclusion rule.

In the event of the sale of a principal residence, a certain portion of the gain ($250,000 for a single taxpayer and $500,000 for joint filers who meet certain conditions) can be excluded from income by the seller even if the sale proceeds are not reinvested into another primary residence. When a principal residence is sold on an installment basis to the purchaser (i.e., with seller financing), this exclusion is also available. However, if after the sale, the seller repossesses the residence as a result of a default by the buyer of the installment financing, the exclusion is lost unless the seller resells the repossessed residence within one year after the date of the repossession.

In DeBough, the 8th Circuit found that the taxpayer had to recognize long term capital gain on the reacquisition of a home sold to a buyer who subsequently defaulted on the obligations to pay the financed portion of the purchase price to the seller-taxpayer, including the amounts previously excluded from income under the principal-residence exclusion rule. If the taxpayer had resold the residence within one year after its reacquisition, the result would have been different.

This decision reminds sellers of principal residences who are considering seller financing of the sale to take into account the tax risk (i.e., risk of adverse tax consequences in the event of default by the buyer) as well as the economic risk of default by the buyer who purchases a residence with seller financing.

For more information, please call Ralph Z. Levy, Jr. in our Nashville office at 615-620-1733.