Specific Comments on the Proposed Section 121 Regulations
(Reg-105235-99; October 10, 2000)
May 1, 2001

I.  Definition of a Principal Residence

Comments

1. Better Guidance is Needed on the Identification of the Property that is the Principal Residence

In some situations, it may not be obvious as to how much of a tract of land and its structures constitutes a principal residence. For example, a taxpayer may have a residence located on several acres of land or have additional structures on the land. In some cases, parts of the property may have been used for business purposes in prior years. There have been cases and rulings under former Section 1034 on how much of a taxpayer’s property constituted a principal residence. These same types of situations are likely to exist under present Section 121, and additional guidance in the regulations would be helpful. Some of these prior cases and rulings are explained here to illustrate the type of additional guidance that would be useful.

In a 1997 case, the Service contended that approximately 43 acres of taxpayer's property adjacent to his residence was held for investment because it would be possible to subdivide the property and sell it. However, the Tax Court found that the taxpayer presented credible testimony that he had no intent to use the acreage for other than personal purposes, including "appreciating nature, living in open spaces, hiking, horseback riding, and enjoying unobstructed views of the countryside…. Nothing in section 1034 prohibits us from finding that such use constitutes ‘significant use’ for residential purposes."² Thus, taxpayer intent and actual use swayed the court to conclude that acreage surrounding a home was held for residential, rather than for investment or business use.

In Revenue Ruling 56-420,³ where a taxpayer sold a portion of the land on which his principal residence was located, there was held to be no sale of a principal residence. In Revenue Ruling 76-541,⁴ a taxpayer sold his principal residence along with 3 of the 10 acres of land surrounding it. The taxpayer planned to build a new home on the retained acreage. However, within 2 years of the sale of the home, taxpayer sold another 2 acres of the remaining 7-acre parcel. The ruling concluded that the sale of the 2 acres fell under former Section 1034 because it was sold within the Section 1034 replacement period and was "proximately related to the sale of the dwelling unit."

Recommendation: Prop. Reg. §1.121-1(b) should be expanded to address the above rulings. The regulations should state that, in identifying the property that constitutes a residence for Section 121 purposes, the taxpayer’s intent and actual use should be considered. The size and nature of a property should not be the sole determining factors. Where property which includes a dwelling and its surrounding property has been used for residential purposes, rather than for business or investment purposes, it should be considered a residence for Section 121 purposes. Additional factors that may be relevant in determining the taxpayer’s intent as to the use of the property should include real estate records, such as property tax assessments. For example, where a jurisdiction allows for a homeowner’s exemption to reduce property taxes on property that is the owner’s principal residence, such an exemption covering an entire property (structure and land) would be a factor indicating that the entire property is a principal residence for Section 121 purposes.