July 1, 2014

The Tax Court has concluded that a taxpayer who sold his primary residence and excluded gain, then reacquired it after the buyers defaulted, had to recognize long-term capital gain on the reacquisition, including amounts previously excluded.

In 2006, Marvin Debough sold his personal residence, which he had owned for 40 years. Under the terms of the sales contract, the buyers were to make installment payments until July 2009, at which time the remaining balance would become due and payable.

In 2006, 2007 and 2008, Debough received payments from the buyers. After excluding $500,000 of the gain from the sale of a principal residence and making an installment sale calculation, Debough reported $56,920 of taxable gain during 2006-2008. During those years, he received $505,000 of principal payments from the buyers.

Subsequently, the buyers failed to comply with the terms of the contract, and Debough ultimately reacquired the property in 2009. After some debate, both Debough and the IRS agreed on the basis of the property sold that he had gain to recognize as a result of reacquiring the property. They disagreed as to the amount.

Debough thought that most of the gain should be excluded as gain from the sale of a principal residence. The IRS determined that his gain was $448,080 – the $505,000 cash Debough had received during 2006-2008, less the $56,920 gain he reported during those years.

Internal Revenue Code Section 1038 governs reacquisitions of real property and provides the rules regarding a reacquisition of a principal residence for which gain had been excluded. If the reacquired property is resold within one year of the reacquisition, the resale is treated as part of the original sale. The IRS said that the exclusion was not available to Debough because he did not sell the property within one year after he had reacquired it.

The Tax Court agreed with the IRS. In addition to agreeing with the IRS’s technical reasoning, the court found that there was “nothing unfair” in taxing the income since Debough was actually in a better position than he was before the sale, having both ownership of the property and $505,000 in cash (Marvin E, Debough v. Commissioner, 142 TC No. 17, May 19, 2014).

This article was originally posted on July 1, 2014 and the information may no longer be current. For questions, please contact GRF CPAs & Advisors at marketing@grfcpa.com.