Could a couple choose the federal home-sale gain exclusion for their former Virginia residence when another home also qualified?

Subject

Couple could choose the gain exclusion for their former Virginia home

Plain-English summary

Virginia allowed the couple to exclude gain from the September 2005 sale of their former Virginia residence. They had moved their domicile to State A in March 2003, sold one State A home in April 2005, and sold the Virginia home later that year.

Both properties met the federal principal-residence use test: the Virginia home was used for two years and five months, and the original State A home for two years and one month, within the applicable five-year periods.

Because IRC § 121(f) permitted an election not to apply the exclusion to one qualifying sale, the couple could choose which home's gain to exclude. Their federal return chose the Virginia residence, so the Virginia assessment and interest were abated.

What this means for you

• More than one residence can satisfy the principal-residence use test.
• The exclusion generally cannot be used for two sales within two years.
• The federal election can determine which qualifying gain receives the exclusion.
• Virginia followed the properly elected federal treatment here.

Common questions

Did moving to State A prevent the former Virginia home from qualifying?

No. The couple still met the two-years-of-use requirement within the five years ending on its sale.

Why could they choose the Virginia sale?

IRC § 121(f) allowed them not to apply the exclusion to the other qualifying residence.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322.
• IRC § 121, including § 121(b)(3)(A) and § 121(f).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-110

Original ruling text

July 16, 2009

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to your clients, * (the "Taxpayers") for the taxable year ended December 31, 2005.

FACTS

In July 1988, the Taxpayers purchased a residence in Virginia where they commenced to reside on a full time basis. The Taxpayers purchased a residence in * (State A) in February 2003. They changed their domiciliary residence from Virginia to State A In March 2003.

The Taxpayers sold their State A residence in April 2005, and purchased another home in State A that month. The Taxpayers then sold their Virginia residence in September 2005. The Taxpayers excluded the capital gain from the sale of their Virginia home on their 2005 federal income tax return pursuant to Internal Revenue Code (IRC) § 121. The Department disallowed the exclusion on the basis that the State A residence was the Taxpayers' principal residence subject to the IRC § 121 exclusion.

The Taxpayers appeal the disallowance of the exclusion and contend both the Virginia and State A residences qualified as principal residences, and they were entitled to exclude the capital gain from either sale.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. For individual income tax purposes, Virginia "conforms" to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Va. Code § 58.1-322.

IRC § 121 provides that gross income does not include gain realized from the sale or exchange of a taxpayer's principal residence. A principal residence will qualify for the exclusion so long as it has been used as such for an aggregated period of at least two years during the five-year period ending on the date of the sale or exchange. In most cases, the exclusion can only be used for the gain on a principal residence once every two years. See IRC § 121(b)(3)(A).

When a taxpayer has more than one sale of a principal residence in a two-year period, the residence that the taxpayer uses a majority of the time during the year ordinarily will be considered the taxpayer's principal residence. However, IRC § 121(f) permits the taxpayer to make an election not to have the exclusion apply to a gain on the sale of a principal residence. This provision essentially allows taxpayers to choose which gain on the sale of a primary residence will be excluded.

The Taxpayers used their Virginia residence as a principal residence from September 2000 through March 2003, an aggregated period of two years and 5 months. The Taxpayers used their original State A home as their primary residence from March 2003 through April 2005, an aggregated period of two years and one month. As such, each residence qualified as a principal residence, and the Taxpayers could chose which gain to exclude pursuant to IRC § 121(f). In this case, the Taxpayers chose to exclude the gain from the sale of the Virginia residence.

Based on the foregoing, the Taxpayers were entitled to and properly excluded the capital gain from the sale of their Virginia home on their 2005 federal income tax return pursuant to Internal Revenue Code (IRC) § 121. Accordingly, the assessment of income tax and interest for the 2005 taxable years will be abated. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2739931318.B