Question

Laura, age 30, has owned her principal residence (adjusted basis of $225,000) in Jamestown, North Dakota, for five years. During the first three years of ownership, she occupied it as her principal residence. During the past two years, she was in graduate school and rented the residence. After graduate school, Laura returned to Jamestown but decided to purchase a different residence for $400,000 and listed her old residence for sale at $340,000. Due to a slow real estate market, 11 months later Laura finally receives an offer of $330,000.

Prepare a detailed analysis with calculations that addresses each of the following.

1. What is Laura's recognized gain if she immediately accepts the $330,000 offer (i.e., 11 months after the listing date)? Selling expenses are $20,000.

2. What is Laura's recognized gain if she rejects the $330,000 offer and accepts another offer of $340,000 three months later (i.e., 14 months after the listing date)?

3. Advise Laura as to which offer she should accept based on potential tax savings (assume that she is in the 24% tax bracket).

**This is the information provided, it says assume the 24% tax bracket; but nothing about rate of interest.

Adapted from Southwestern Federal Taxation 2019: Comprehensive, 42ndedition, Maloney, Raabe, Hoffman, Young

Answer 1

You don't have to live in the house at the time you sell it to apply for the home sale exclusion. Your possession and use of the products for two years will happen at any time within five years of sale date. That means, for example, that for up to three years you can move out of the house and still be excluded.

In the first scenario (a), the offer was accepted after 11 months of listing. Which means that 2 years and 11 months have passed since Laura actually lived in the house. So she is eligible for exclusion under IRS 121 rule.

In the Second scenario (b), the offer was accepted after 14 months of listing. This means that more than 3 years have passed since Laura actually lived in the house. Hence, She is not eligible for exclusion under IRS 121 rule.

Now, let's look at the solution:

a.         Amount realized ($330,000 − $20,000)                           $ 310,000

            Value using Adjusted basis                                              (225,000)

            Realized gain                                                                    $   85,000

            IRS 121 exclusion                                                              (85,000)

            Recognized gain                                                              $        –0–

b.         Amount realized ($340,000 – $20,000)                            $ 320,000

            Value using Adjusted basis                                               (225,000)

            Realized gain                                                                   $   95,000

            Recognized gain                                                              $ 95,000

Laura is not eligible for the IRS 121 exclusion as she does not satisfy the two out of five year occupancy requirement, she is not eligible for the IRS 121 exclusion. Thus, her realized gain of $95,000 is recognized.

c.         Laura should accept the First offer ($330,000). The recognized gain on the $340,000 offer is liable to a tax cost of $14,250 ($95,000 × 15% capital gain rate).

           So, her cash inflow from the second offer ($340,000) is only $305,750 ($340,000 − $20,000 − $14,250), whereas her cash inflow from the First offer ($330,000) is $310,000 ($330,000 − $20,000).