Eighth Circuit: Reacquisition of property, principal-residence exclusion

Reacquisition of property, principal-residence

The U.S. Court of Appeals for the Eighth Circuit today affirmed an opinion of the U.S. Tax Court that concluded that the taxpayer was not entitled to the principal-residence exclusion under section 121 because the taxpayer had not resold the reacquired property within one year pursuant to the rules for calculating gain with respect to certain reacquisitions of property under section 1038.

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The case is: DeBough v. Commissioner, No. 14-3036 (8th Cir. August 28, 2015). Read the Eighth Circuit’s decision [PDF 84 KB] 

Summary

The taxpayer in 1966 purchased a residence on 80 acres of mixed-use land for $25,000 in Minnesota. In 2006, the taxpayer agreed to sell the property for $1.4 million pursuant to an installment contract. Because the property was the taxpayer’s principal residence, he excluded $500,000 of gain from income on his tax return for 2006. This left approximately $158,000 of taxable income on the sale of the property. The taxpayer reported this income as installment sale income, beginning in 2006. 

The taxpayer received a total of $505,000 from the buyers and reported a total of about $57,000 as taxable installment sale income for tax years 2006, 2007, and 2008.

In 2009, the buyers defaulted, and the taxpayer reacquired the property, incurring about $4,000 in costs related to the reacquisition. The taxpayer kept the $505,000 he had previously received from the buyers as liquidated damages. On his 2009 tax return, the taxpayer treated this event as a reacquisition of property in full satisfaction of indebtedness under section 1038. In calculating the amount of his realized gain on the reacquisition, the taxpayer again applied the $500,000 principal-residence exclusion. The taxpayer then reported about $97,000 as long-term capital gains related to the reacquisition of the property for tax year 2009. He did not resell the property.

In 2012, the Commissioner sent the taxpayer a notice of deficiency with respect to his 2009 tax return. The Commissioner determined that the taxpayer had underreported some $448,000 in long-term capital gain for tax year 2009 by applying the principal-residence exclusion in his calculation of gain. 

The taxpayer filed a petition with the Tax Court, seeking a redetermination of the deficiency for tax year 2009. The Tax Court agreed with the Commissioner, finding the taxpayer was not entitled to the principal-residence exclusion because he had not resold the property within one year, pursuant to the rules under section 1038(e), that when a taxpayer reacquires a principal residence but resells it within one year after the date of the reacquisition, the resale of the property would be treated as part of the transaction constituting the original sale of the property. 

Today, the Eighth Circuit affirmed.

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