Section 121 exclusion of capital gains available if nursing home resident resided in home 1 of last 5 years

Sale or transfer of a primary residence is often a major consideration in elder care planning. Property may be transferred from an infirm spouse to the “healthy spouse.” Property may be sold because the homeowner has to move into a nursing home or other care facility. Property may be transferred to the “caregiver child” in connection with a Medicaid application. A residence may be transferred “to the kids” to preserve its value for their benefit. When a sale or transfer takes place, there may be substantial capital gains incurred due to the large increase in value that has occurred during the decades that the elder resided in the property since time of purchase. This is where Section 121 of the Internal Revenue Code comes in. Let’s examine a few of the provisions.

Section 121 provides an exclusion from income tax of up to $250,000 of capital gains ($500,000 for a married couple) once every two years upon sale of the primary residence. The basic requirement is that the seller has resided in the property for 2 of the 5 years prior to sale. This would mean at least 2 years from the date the seller acquired title.

What about sales by widow/widowers? Under Section 121(b)(4), if the widow/er sells the residence within 2 years of the death, and all the other basic criteria are met, they can exclude up to $500,000 of gain.

What if the seller didn’t reside in the house the entire time? The time in which the person resided elsewhere before moving out for good is referred to as “nonqualified use,” and Section 121(b)(5)(C) specifies that there will be a proportional reduction in the exclusion based on the ratio of nonqualified use since 2009 to the whole period. There are a few exceptions.

What if the couple is married filing jointly, but only one spouse meets all of the requirements? Under Section 121 (d), They can claim the full $500,000 exclusion.

What if the seller has to move into a nursing home before the sale, or has resided in and out of health care facilities during the 5 years before the sale? Section 121(d)(7) has special provisions about that. If the individual “becomes physically or mentally incapable of self-care” and resided in the home for periods of time that, in aggregate, equal at least 1 year out of the past 5, “then the taxpayer shall be treated as using such property as the taxpayer’s principal residence during any time during such 5-year period in which the taxpayer owns the property and resides in any facility (including a nursing home) licensed by a State or political subdivision to care for an individual in the taxpayer’s condition.”

What if the parent transfers the property to a child who does not live there? The Section 121 capital gains exclusion will not be available to a family member who has received the property but then does not use it as his/her primary residence. When the property is later sold, there will be probably be capital gains to contend with, because the adjusted cost basis in the hands of the parent is “carried over” to the child who received the property.

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