1. PROPOSAL FOR AMENDING I.R.C. §121 and §1034

 

Regarding: A proposal to allow a $500,000 exclusion of gain from the sale of a principal residence (Clinton proposal, with a clarification for divorces or legal separations)

 

PRESENT LAW

Gain on the sale or exchange of a principal residence generally is includible in gross income and is subject to a maximum rate of 28 percent. If an individual purchases a new principal residence within two years of selling the old residence, gain from the sale of the old residence (if any) is recognized only to the extent that the taxpayer’s adjusted sales price exceeds the taxpayer’s cost of purchasing the new residence (sec. 1034).

In general, a taxpayer may exclude from gross income up to $125,000 of gain from the sale or exchange of a principal residence if the taxpayer (1) has attained age 55 before the sale and (2) has used the residence as a principal residence for three or more years of the five years preceding the sale. This election is allowed only once in a lifetime unless all previous elections are revoked. For these purposes, sales on or before July 26, 1978 are not counted against the once in a lifetime limit.

Only one spouse is required to satisfy those tests in order to be eligible for the exclusion, but that spouse alone must meet all the requirements. Married couples are entitled to only one $125,000 exclusion between them if they file jointly; if they file separately, they are entitled to only $62,500 each. Unmarried individuals are each entitled to exclusions of $125,000. The Section 121 exclusion was increased from $100,000 to $125,000 in 1981. It has not been changed for the effects of inflation since that time.

President Clinton has proposed to repeal the section 121 exclusion and section 1034 rollover rules and replace them with a $500,000 married/$250,000 single exclusion of gain on the sale of a home. It would be available once every two years.

 

RECOMMENDED CHANGE

Section 121 would be amended so that taxpayers of any age would be eligible for an exclusion up to $500,000 per residence for the gain from the sale of a principal residence. This exclusion would be available to taxpayers once every two years. No filing would be required for selling prices up to $500,000 if no prior sale occurred within two years.

The exclusion would be allowed if the residence was the principal residence of either of the spouses at the time of legal separation or divorce. The exclusion would apply if the residence was sold pursuant to a divorce decree or legal separation. Related provisions, such as the home mortgage interest expense deduction, would also apply in these cases of divorced or separated taxpayers if the residence was one of the spouse’s principal residence at the time of divorce or legal separation.

The current law $125,000 one-time exclusion for gain on sale of residence by qualifying taxpayers that are age 55 or older would be eliminated. The current law section 1034 two year rollover provision for deferral of gain on sale of principal residence would also be eliminated.

 

REASON FOR CHANGE

The principal residence is the major asset for most middle-income taxpayers. The increase in value reflected in this asset is in most cases, not a true economic gain. Rather, it represents the impact of inflation on the original purchase price of the asset. The recommended change would simplify the recordkeeping and tax payment process for over 60 million homeowners. Older couples selling their home for retirement income or to move into a smaller apartment or to live with family and who have a gain exceeding the current $125,000 one-time exclusion would be able to exclude their gain and keep more of the funds for retirement and elderly care needs. This proposal would assist in the preservation of capital so important to elderly taxpayers in the retirement years. This provision would allow the elderly to remain in their homes longer and be more self sufficient. Middle class families changing jobs and moving to communities with lower housing costs would be able to exclude the gain up to $500,000 and thus use the money for other household needs. In addition, inner city and rural communities with low housing costs could be more attractive to homeowners wishing to purchase a home and keep some of the gain for other purposes.

There are many taxpayers who are going through divorces and legal separations that take more than two years to complete. The divorce process is difficult and stressful, without considering the unfair tax consequences that often result under current law. In most divorce situations, one spouse must leave the marital residence several months or years prior to the residence being sold or the divorce finalized. In fact, many divorced taxpayers do not sell the residence that was their "principal residence" until the children are finished with their education.

This change would recognize that taxpayers marry, buy homes, and often have many problems in dissolving the marriage, the least of which should be the tax ramifications. Divorced and separated spouses should have the benefits of gain exclusion. This provision would clarify that divorced taxpayers no longer residents of a principal residence may exclude up to $500,000 of gain per residence if the residence was the principal residence of either spouse at the time of legal separation or divorce and would overrule the court positions in Young and Perry. Intervening time between when a spouse moves out of the residence and the sale would not prevent the spouse from excluding up to $500,000 of gain on the sale of the residence.

 

2. PROPOSAL FOR AMENDING I.R.C. §121

 

Regarding: A proposal to increase the one-time exclusion of gain from the sale of a principal residence by taxpayers that have attained age 55 and age 65.

 

PRESENT LAW

Section 121 provides for an election to exclude up to $125,000 of gain from the sale of a principal residence if the taxpayer is at least age 55 and has owned and resided in the residence for at least three of the preceding five years. Only one spouse is required to satisfy those tests in order to be eligible for the exclusion, but that spouse alone must meet all the requirements. Married couples are entitled to only one $125,000 exclusion between them if they file jointly; if they file separately, they are entitled to only $62,500 each. Unmarried individuals are each entitled to exclusions of $125,000. The Section 121 exclusion was increased from $100,000 to $125,000 in 1981. It has not been changed for the effects of inflation since that time.

 

RECOMMENDED CHANGE

Section 121 would be amended so that the exclusion for the gain from the sale of the principal residence by a taxpayer age 65 and over at the time of the sale, who otherwise meets the requirements of Section 121, would be $200,000. The current $125,000 exclusion would be kept in place for qualifying taxpayers that are ages 55 to 64. Taxpayers would only be able to claim one exclusion during their lifetime, whether during the ages of 55-64, or at age 65 or older.

In addition, both the $125,000 and $200,000 exclusions would be indexed for inflation annually using rules similar to those contained in Section 1(f)(3).

 

REASON FOR CHANGE

When section 121 was created, Congress recognized that the age of taxpayers was important for exclusion of gain on the sale of residence. It was clear that this provision was designed to assist elderly taxpayers. Since that time, the elderly population in this country is increasing. The $200,000 second tier exclusion would benefit those taxpayers with a dwindling ability to work and bring in additional income.

The principal residence is the major asset for most middle-income taxpayers. The increase in value reflected in this asset is in most cases, not a true economic gain. Rather, it represents the impact of inflation on the original purchase price of the asset. In general, older taxpayers tend to own their homes for a long period of time and have had their home sale gains more affected by inflation.

At the time that most elderly taxpayers sell their principal residence, they are counting on the proceeds from the sale to cover their living costs during their retirement years. As a result, they are unable to meet the reinvestment requirements of Section 1034 to defer the gain on the sale of the principal residence and are often subject to income tax on the gain. The income taxes due from the sale of the residence reduces the funds available to pay for retirement needs. This proposal would assist in the preservation of capital so important to elderly taxpayers in the retirement years. This provision would allow the elderly to remain in their homes longer and be more self sufficient.

 

3. PROPOSAL FOR AMENDING I.R.C. §121

 

Regarding: A proposal for marriage penalty relief for the one-time exclusion of gain from sale of principal residence for certain spouses

 

PRESENT LAW

In general, a taxpayer may exclude from gross income up to $125,000 of gain from the sale or exchange of a principal residence if the taxpayer (1) has attained age 55 before the sale and (2) has used the residence as a principal residence for three or more years of the five years preceding the sale. This election is allowed only once in a lifetime unless all previous elections are revoked. For these purposes, sales on or before July 26, 1978 are not counted against the once in a lifetime limit. The current $125,000 amount applies to all taxpayers except those married filing separately, for which the amount is $62,500.

 

RECOMMENDED CHANGE

Section 121 would be amended to allow a $125,000 exclusion to an individual who otherwise qualifies for an exclusion under section 121 of the Code but for a marriage to a spouse who has previously made the section 121 election. The exclusion would only be available if the individual held the property which is the subject of the exclusion for at least three years. Also, the $125,000 amount should be indexed annually for inflation.

 

REASON FOR CHANGE

Present law contains a marriage penalty that needs to be corrected. Under present law, a well informed individual may make a section 121 election immediately before marriage to another individual (who has previously made a section 121 election) to exclude up to $125,000 of gain on a principal residence owned before marriage. However, a less knowledgeable and less informed, but otherwise similarly situated individual, who does not make the election before said marriage is denied the $125,000 exclusion. Taxpayers are being disadvantaged under present law when they marry someone who has already taken the exclusion prior to the marriage. The AICPA believes that on a remarriage, where one of the spouses has never taken the $125,000 exclusion, that individual and spouse should be able to take the $125,000 exclusion on a joint return regardless of whether one of the spouses has previously taken the exclusion prior to the marriage.

This change would preserve the current law’s intent and would remove the current law "marriage penalty/tainted spouse" effect common with second marriages. The majority of Americans rely on the equity build up in their primary residence for their retirement income. Allowing individuals to preserve the gain on the sale of their primary residence provides the means to economic independence in senior years -- a laudable result of this tax law modification.

 

4. PROPOSAL FOR AMENDING I.R.C. §1034

 

Regarding: A proposal to allow certain divorced or separated spouses the rollover of gain from the sale of a principal residence by taxpayers that have reinvested the proceeds

 

PRESENT LAW

Current §1034 allows a taxpayer who sells a personal residence to defer any gain on the sale by purchasing a new residence. The taxpayer must purchase the new residence within the period beginning two years prior to the sale and ending two years after the sale. To completely defer the gain, the purchase price of the new residence must equal or exceed the sale price of the old residence.

A second rule, in code §121, allows taxpayers who are 55 or older to exclude gain of up to $125,000 on the sale of a principal residence that they have occupied for 3 of the 5 years prior to sale. This exclusion may only be used once by a taxpayer and spouse.

In the case of Young v. Commissioner, T.C. Memo 1985-127, the Tax Court held that the taxpayer abandoned the principal residence when the taxpayer left the marriage, and, therefore, was not eligible for section 1034 rollover treatment on the subsequent sale of the interest to the ex-spouse. In a more recent case, Perry v. Commissioner, 78 AFTR2d par. 96-5203, the taxpayer argued that the sale of the home was prevented by external circumstances out of the taxpayer’s control, similar to circumstances in the Green v. Commissioner, T.C. Memo 1992-439, case because the family law court would not allow the taxpayer to evict the ex-spouse and child in order to sell the residence at the time that the taxpayer left the marriage. The Perry court ruled that divorce is not the type of external, objective circumstance that allows a taxpayer not in possession of a home to be deemed a resident therein for purposes of section 1034(a).

 

RECOMMENDED CHANGE

The rollover of gain on the sale of a residence would also apply, in the case of divorced or separated taxpayers selling homes and reinvesting the proceeds, if the residence was one of the spouse’s principal residence at the time of divorce or legal separation. The rollover would apply if the residence was sold pursuant to a divorce decree or legal separation. Related provisions, such as the home mortgage interest expense deduction, would also apply in these cases of divorced or separated taxpayers if the residence was one of the spouse’s principal residence at the time of divorce or legal separation.

 

REASON FOR CHANGE

Congress created the section 1034 rollover provision to allow some relief to taxpayers selling homes and reinvesting proceeds. There are many taxpayers who are going through divorces and legal separations that take more than two years to complete. The divorce process is difficult and stressful, without considering the unfair tax consequences that often result under current law. In most divorce situations, one spouse must leave the marital residence several months or years prior to the residence being sold or the divorce finalized. In fact, many divorced taxpayers do not sell the residence that was their "principal residence" until the children are finished with their education.

Section 1034 needs to be modified to be available to divorcing taxpayers who move out of their home because of domestic relations problems several years prior to the actual sale. This change would recognize that taxpayers marry, buy homes, and often have many problems in dissolving the marriage, the least of which should be the tax ramifications. Divorced and separated spouses should have the benefits of section 1034. This recommended change would clarify that divorced taxpayers no longer residents of a principal residence may claim section 1034 treatment if the residence was the principal residence of either spouse at the time of legal separation or divorce or was sold pursuant to a divorce decree or legal separation and would overrule the court positions in Young and Perry. Intervening time between when a spouse moves out of the residence and the sale would not prevent the spouse from deferring gain on the sale by purchasing a new residence.

 

5. PROPOSAL FOR AMENDING I.R.C. §1034

 

Regarding: A proposal to allow payments to CCRCs to be included in the proceeds reinvested in a new residence (i.e., qualified rollover) for purposes of deferral of gain from the sale of a principal residence

 

PRESENT LAW

Current §1034 allows a taxpayer who sells a personal residence to defer any gain on the sale by purchasing a new residence. The taxpayer must purchase the new residence within the period beginning two years prior to the sale and ending two years after the sale. To completely defer the gain, the purchase price of the new residence must equal or exceed the sale price of the old residence.

A second rule, in code §121, allows taxpayers who are 55 or older to exclude gain of up to $125,000 on the sale of a principal residence that they have occupied for 3 of the 5 years prior to sale. This exclusion may only be used once by a taxpayer and spouse.

The IRS has ruled that payments for admission to a retirement facility do not qualify as the purchase of a residence (Rev. Rul. 60-135, 1960-1 C.B. 298). The taxpayer in such a situation obtains future support and does not acquire title to real estate; therefore, the deferral rules do not apply.

 

RECOMMENDED CHANGE

The rollover of gain on the sale of a residence would also apply to taxpayers selling homes and using the proceeds to make a deposit (i.e., fee that is not applied to monthly maintenance costs) to a continuing care retirement community. The payment of a deposit in connection with a continuing care contract, as defined in section 7872(g)(3), would be treated as a purchase of a new residence under §1034. If a deposit fee is refunded to the taxpayer, the refund would be treated as proceeds from the sale of a residence, and the corresponding gain from the refund could be deferred if reinvested in another residence within the two years required under §1034.

 

REASON FOR CHANGE

Taxpayers who enter continuing care or retirement facilities generally are at a point where they need the care provided and are not able to manage the burdens of home ownership. The typical new resident is in his or her seventies. Often, the only source of funds for the required deposit is the proceeds from the sale of a prior residence. In many cases, taxpayers have owned their homes for many years and inflation has created a gain of more than $125,000. Consequently, these taxpayers are subjected to income tax on the gain from selling their residence when they need the funds for the continuing care facility.

The proposal would eliminate this problem by adding a section to the definition of new residence which would allow a continuing care facility to qualify as a replacement residence. This change will allow taxpayers to avoid tax on any proceeds that they use for a deposit in a continuing care facility.

Congress has created a definition of "qualified continuing care facility" in §7872(g)(3). We propose that this definition be utilized for purposes of the deferral under §1034.

 

6. PROPOSAL FOR AMENDING I.R.C. §121

 

Regarding: A proposal to modify the measurement period for residing in the principal residence for purposes of exclusion on sale of residence incident to divorce

 

PRESENT LAW

Section 121 provides for an election to exclude up to $125,000 of gain from the sale of a principal residence if the taxpayer is at least age 55 and has owned and resided in the residence for at least three of the preceding five years. Only one spouse is required to satisfy those tests in order to be eligible for the exclusion but that spouse alone must meet all the requirements. Married couples are entitled to only one $125,000 exclusion between them if they file jointly; if they file separately, they are entitled to only $62,500 each. Unmarried individuals are each entitled to exclusions of $125,000.

 

RECOMMENDED CHANGE

Section 121 would be amended so that, if a residence is sold pursuant to a divorce or separation, the eligible spouse(s) would be able to utilize the gain exclusion if during the six (instead of the present five) year period ending on the date of the sale or exchange, the residence was used by the taxpayer as his or her principal residence for periods aggregating three years or more.

 

REASON FOR CHANGE

Divorce is a unique transition for taxpayers. In most cases, one spouse must involuntarily abandon the marital residence. In many cases, as part of the property settlement, the residence is sold. Until then, the spouse who abandoned the residence may live in somewhat temporary lodging (e.g., rental). His or her last permanent residence was the marital residence. A safe harbor is needed in the law for such taxpayers to utilize §121 if the residence is sold pursuant to a divorce settlement. Divorces often take more than two years to complete. Further, it may take additional time to complete sale of the residence after the agreement is finalized. Thus, an extra year (i.e., three of six instead of three of five) is necessary to permit §121 qualification.

 

7. PROPOSAL FOR AMENDING I.R.C. §1034

 

Regarding: A proposal to allow capital losses to be deducted on the sale of a principal residence by taxpayers

 

PRESENT LAW

Taxpayers generally may claim as a deduction any loss sustained during the taxable year and not compensated by insurance or otherwise. In the case of an individual, however, the deduction is limited to: (1) losses incurred in a trade or business, (2) losses incurred in any transaction entered into for profit though not connected with a trade or business, and (3) catastrophic losses on property that arise from fire, storm, shipwreck, or other casualty or from theft. Losses from the sale or exchange of capital assets are offset against capital gains and then deductible subject to the limitations described above. In addition, taxpayers other than corporations may deduct capital losses against up to $3,000 of ordinary income each year. A loss on the sale or exchange of a principal residence is treated as a nondeductible personal loss.

Gain on the sale or exchange of a principal residence generally is includible in gross income and is subject to a maximum rate of 28 percent. If an individual purchases a new principal residence within two years of selling the old residence, gain from the sale of the old residence (if any) is recognized only to the extent that the taxpayer’s adjusted sales price exceeds the taxpayer’s cost of purchasing the new residence (sec. 1034). A taxpayer also may elect to exclude from gross income up to $125,000 of gain from the sale of a principal residence if the taxpayer: (1) has attained the age of 55 before the sale, and (2) has used the residence as the principal residence for three or more years of the five years preceding the sale of the residence (sec. 121). This election maybe made only once.

 

RECOMMENDED CHANGE

Losses from the sale or exchange of a principal residence would be treated as a deductible capital loss rather than a nondeductible personal loss. Therefore, the loss would be allowed to offset capital gains and any excess could be deducted up to $3,000 in the current year and the remainder carried over to future years.

 

REASON FOR CHANGE

There is an inequity in the current law with gains on sales of personal residences being includible in gross income and taxed, but losses not allowed as a deduction. The loss on the sale of a personal residence often represents a true economic loss of the taxpayer. In addition, many taxpayers are forced to sell their homes when they change jobs and are not able to time the sale to when the real estate market is on the rise. Many real estate prices in different parts of the country have decreased, especially during downturns in the economy and in the real estate market. Taxpayers in these circumstances should receive some tax relief.

 

8. Draft letter for the Senator to send to Treasury/IRS on periodic payments to CCRCs qualifying partly for the qualified long-term care services/medical expense itemized deduction

 

January XX, 1997

 

The Honorable Donald C. Lubick
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Room 3120
Washington, D.C. 20220

 

The Honorable Margaret Richardson
Commissioner
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re: Clarification that some of the periodic payments to CCRCs are eligible deductible medical expenses

 

Dear Assistant Secretary Lubick and Commissioner Richardson:

 

As you are probably aware, section 322 of the Health Insurance Portability and Accountability Act of 1996, enacted on August 21, 1996, (P.L. 104-91, H.R. 3103) provides that expenses for qualified long-term care services (as defined in Internal Revenue Code (IRC) section 7702B(c)) are allowed as IRC section 213 medical expense itemized deduction, subject to the seven and half percent of adjusted gross income floor.

Specifically, IRC section 213(d)(1)(C) was changed to include "qualified long-term care services" within the definition of medical expenses for purposes of deductions. The term "qualified long-term care services" is defined in new IRC section 7702B(c)(1) as "necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services, which -- (A) are required by a chronically ill individual, and (B) are provided pursuant to a plan of care prescribed by a licensed health care practitioner."

A "licensed health care practitioner" is defined in IRC section 7702B(c)(4) as "..any physician (as defined in section 1861(r)(1) of the Social Security Act) and any registered professional nurse, licensed social worker, or other individual who meets such requirements as may be prescribed by the Secretary. "

The key issue here is whether services provided by a continuing care facility and home health care constitute services provided pursuant to a plan of care prescribed by a "licensed health care practitioner." If they do, a portion of the periodic payments to a continuing care facility and payments for home health care should qualify as medical expenses. Since it appears from the statute that the Secretary will be issuing regulations to define "other individual" under section 7702B(c)(4), I strongly suggest that this issue be addressed in those or related regulations.

My understanding is that, in general, continuing care retirement communities provide medical services and have a doctor on call, nurses on staff, and assist with medications for residents in exchange for some of the periodic amounts paid for to these facilities. In addition, the services provided as part of a home health care plan of action are those described as meeting the definition of "qualified long-term care services." Therefore, it seems that some of the periodic payments to such facilities and all payments for home health care services should qualify as amounts for qualified long-term care services eligible medical expense itemized deduction. However, I leave it to you and your staff to better analyze the situations and details to be covered by the regulations. If the legislative intent is not clear or a legislative correction is needed for this, I would be glad to talk to you further about this and consider introducing legislation in this area.

I look forward to your review of this area and any forthcoming regulation addressing this matter. Please let me know if I can be of assistance with this effort.

 

I appreciate your consideration of this matter.

 

Sincerely,

 

The Honorable Barbara Mikulski (D-MD)
United States Senate

 

cc: Robert H. (Buff) Miller, Acting Deputy Tax Legislative Counsel for Regulatory Affairs, Department of the Treasury, Room 4206