Newly Married Couple Sec 121

"Taxpayer" & "spouse" are a newly married couple, in their 50s (not their first marriages). Both taxpayer and spouse own their own, separate residences prior to and at the start of the marriage. Both houses have large appreciation, above and beyond the $250k exclusion taxpayer and spouse are separately allowed under Sec 121. Taxpayer owns house "A" and spouse owns house "B". Both taxpayer and spouse are flexible.

I have suggested that taxpayer move into house B and begin using it as a principal residence. They would sell house B after 2-3 years. I am pretty confident they'd qualify for a $500k exclusion on house B at the time of sale, assuming a joint return. Then, both taxpayer and spouse would move into house A and begin using it as a principal residence.

Would their max potential $500k exclusion on house A be reduced for nonqualified use under Sec 121(b)(5)(C)? My read says yes, it would. However, it appears they still come out well ahead with this strategy.

Section 121(b)(5)(C)(ii)(I) has an exception to the general nonqualified use definition.

“The term ‘period of nonqualified use does not include any portion of the five-year period described in subsection (a) which is after the last date that such property is used as the principal residence of the taxpayer or the taxpayer’s spouse.”

Does this change your read on the issue?

It does not. That excerpt helps out a taxpayer who moves out and never moves back in. e.g. taxpayer moves out of residence after living there for 2 years, never moves back in and sells the property within three years of moving out. Sec 121 is preserved and there's no nonqualified use. At most recharacterization to nonexempt 1250 gain if it was rented and depreciation was taken.

In my example we clearly have the taxpayer moving back in, therefore nonqualified use is "sandwiched" inbetween periods of use as residence, and that excerpt does not apply. e.g. taxpayer lives in property for at least 2 years, moves out for 2-3 years, then moves back in.

I missed the last sentence of your first paragraph, and yes I see your point.

How does the nonqualified use rule apply when you don't have nonqualified use at the start of the ownership? If we assume that the taxpayers move back onto home A and reside there for 2 years, do you have a maximum nonqualified use ratio of 2/6? Lived there for at least 2 years, moved out for 2 years, moved back in for 2 years? If you have at least a $750K gain on home A, you would still get the $500K exclusion would you not? $750K - ($750K X 2/6) = $500K.

If we assume that the taxpayers move back onto home A and reside there for 2 years, do you have a maximum nonqualified use ratio of 2/6? Lived there for at least 2 years, moved out for 2 years, moved back in for 2 years? If you have at least a $750K gain on home A, you would still get the $500K exclusion would you not? $750K - ($750K X 2/6) = $500K.

I agree with your analysis.

What are they going to do with House A while living in House B? Rent it out? Let it sit there vacant?

What are they going to do with House A while living in House B? Rent it out? Let it sit there vacant?

Not going to rent it out. Maybe Taxpayer or Taxpayer's adult child might stay there for a minority of the nights each week.

Ok. What about the temporary absence exception using unforeseen circumstances?

I don't think it'll matter for my situation. Appears that they'll get the full $500k exemption on House A even with the nonqualified use. I made the mistake of thinking exemption was prorated for nonqualified use, but it's pretty clear the gain eligible to be excluded is prorated, not the exemption.

But, to humor you, it would be tough to arrange facts to fit 121(b)(5)(C)(ii)(III) even assuming we get unforeseen circumstances. The temporary absence can't exceed two years, and they need exactly two years of principal residence use from the Taxpayer in House B to get the full $500k on House B. So, timing would have to be perfect and prearranged.

Doesn't meet any of the safe harbors for unforeseen circumstances. I'm sure you could arrange facts that would meet unforeseen circumstances based on a facts and circumstances analysis. The latitude given to taxpayers for what fits unforeseen circumstances is pretty broad.

Both houses will most likely have high 6 figure gain. They've both been resided in for more than two years...at least five years for both.

One should have bought the other's home before the marriage.

One should have bought the other's home before the marriage.

I don't see that as optimal, given the fact pattern and goals.

Well, it's too late now. But why would it not have been optimal?

Let's put some numbers to it... Let's say house B is worth $1 million right now and we expect 5% appreciation each year.

Under my plan above, couple sells house B in 2ish years for approximately $1.1 million and at that time recognize a $600k capital gain....two years from now.

Under your plan, spouse immediately sells House B to taxpayer and recognizes a $750k gain right now...no deferral. The couple then sells the house again two years later to a third party and then realizes a ~$100k gain that is all excluded? If there's something esoteric to your plan that I'm missing, you'll want to chime in. Otherwise, that plan is clearly not optimal.

I'm not too concerned about capital gains rates at this time as they don't appear to have been messed with in the House version of the BBBA.

If you're considering below market sales, this client will not want to get into gift tax return territory and I will not advise that. Taxpayer already has quite a large estate and I don't want him to "blow" exemption on something like this.

It would have been silly to pay cash. A long-term, low-interest note would have been sufficient to utilize 121. Any later appreciation would have been taxed anyway and presumably the interest income would be offset by the interest deduction on a joint return. And if held for rent, depreciation would have increased. So I think it would have been preferable to sell before the marriage.

Besides, as a practical matter, it probably doesn't make sense to keep both homes. My test is whether they would have bought the 2nd home if they did not already have it.

I'd go one step further and say that as a general matter pre-marriage sales present excellent planning opportunities. The parties are still unrelated. In particular, selling a business could be very beneficial. One aspect of such planning is whether the later fact of marriage affects the results. In general I would say not, but there might be something I'm missing. For example, a literal reading of 167 and 267 would suggest that marriage would affect amortization of a term interest.

I've used a prenup in a collection scenario for a physician who got nailed for bad tax shelters, but I'm having trouble remembering how I did it...

Gator, you haven't offered a rebuttal to post #14 or any evidence that what you're proposing, i.e. fiancée sells the house to the fiancé before the marriage, is better for my client for tax purposes than the strategy I am proposing to the client. Therefore, I'll have to disagree with you and move on.

Your take on LBOs of businesses is novel and interesting, but respectfully is not applicable to this client and or this post and just muddies the water for future, less experienced readers.

I respectfully suggest you put them side by side.

This forum is meant to share knowledge with the goal of learning and growth.

You might be the smartest guy in the room. But, if you can't be bothered to prove out your strategy or bare minimum provide a simple explanation of why what you're proposing is better than an alternative I think you'll find posters on TPT will grow less and less receptive toward you.

Your plan has one 121 benefit. I showed you a way to get two 121 benefits with essentially the same economics. If you're not willing to figure it out, that's on you.

I showed you a way to get two 121 benefits with essentially the same economics.

No you didn't.

And I clearly contrasted our two strategies in post #14 using reasonable assumptions and numbers. My strategy is clearly better. If something is incorrect in that post or I've made an error, you're welcome to explain, otherwise this is going nowhere.