Comments on Proposed Regulations Under Section 121
May 1, 2001

Comments Submitted by Standing Committee on Legal Assitance for Military Personnel

January 8, 2001

CC:M&SP:RU (REG-105235-99)
Room 5226
Internal Revenue Service
POB 7604
Ben Franklin Station
Washington, D.C. 20044

Dear Sir/Madam:

The American Bar Association respectfully requests that you modify the proposed regulations to I.R.C. § 121 to suspend the five-year period during which the ownership and use requirements of I.R.C. § 121 must be met for time spent by members of the uniformed services away from the home due to qualified official extended duty. We believe this modification to the proposed regulation would be consistent with the intent of Congress in enacting I.R.C. § 121, the proposed regulation's facts and circumstances test for determining what is a principal residence and what constitutes use as a principal residence, and with other Federal law applicable to members of the uniformed services.

The Taxpayer Relief Act of 1997 significantly modified I.R.C. § 121. Under the modified provision, a single taxpayer may exclude up to $250,000 of gain from the sale of a home concluded after May 6, 1997. Married couples who file jointly may exclude up to $500,000 of gain. To qualify for the exclusion, the taxpayer must have both owned and used the property as a principal residence for two years or more during the five-year period preceding the date of sale.

The significant changes made to I.R.C. § 121 included the repeal of former I.R.C. § 1034, the "roll-over" rules. Given the proper facts, case law applying the "roll over" rules allowed a homeowner to be absent from his or her principal residence for an extended period without it losing its status as principal residence. This section had permitted military members up to four years (to a maximum of eight years for military members serving abroad) to roll over a gain on a sale of a principal residence into a new residence, typically at a new duty station.

Additionally, a rather extensive body of case law as well as the Treasury Regulations enacted under I.R.C. § 1034 permitted a military member qualifying under a "facts and circumstances" test to maintain real property as a "principal residence" under the meaning of the section despite living away from the home due to military orders. ¹ This permitted a military member to maintain parity with other taxpayers and defer capital gains under the rollover provisions of I.R.C. § 1034. In other words, under the rules applicable to I.R.C. § 1034, a military member's military service did not prevent the member from claiming his or her home as a principal residence under I.R.C. § 1034. These members would defer recognition of any profits from that home's sale by decreasing the basis of a subsequently purchased home. And, once the member reached age 55, the member could sell that home and use the former version of I.R.C. § 121 to exclude up to the $125,000 of gain.

The repeal of I.R.C. § 1034 can be interpreted to also repeal the "facts and circumstances" test that enabled military members to qualify the former home as a "principal residence" even when they were away from the home solely due to compliance with official orders. Under the new law, for houses sold after May 6, 1997, a military member must actually "own and use" the property for two years of the five-year period immediately preceding the sale to qualify the property for the complete exclusion. This test is strictly applied. Military homeowners who do not occupy their principal residence for at least two of the five years immediately preceding the date of sale must pay taxes on part or all of the capital gain on the home. This is a particular problem for military members on extended overseas assignments or who are required to live in government housing while stationed in the United States. Because military members and their families are often subject to extended tours of duty away from their principal residence, the "own and use" requirements can result in unfair tax penalties when the principal residence is sold.

Previously, Congress recognized this unintended inequity to military homeowners, and passed a Sense of Congress (H.R. 3616, Section 1074), titled, "Sense Of Congress Concerning Tax Treatment Of Principal Residence Of Members Of Armed Forces While Away From Home On Active Duty." Section 1074 states:

"It is the sense of Congress that a member of the Armed Forces should be treated, for purposes of section 121 of the Internal Revenue Code of 1986, as using property as a principal residence during any continuous period that the member is serving on active duty for 180 days or more with the Armed Forces, but only if the member used the property as a principal residence for any period during or immediately before that period of active duty."

The current version of I.R.C. § 121 has a bright line test based on home ownership duration and use during the five-year period immediately before sale. If, during this period, the military member fails to use his or her house as a principal residence for two years the military member will recognize gain, either partially or fully, on the sale of the house, regardless of the intent that it is a principal residence. If the military member has not lived in the house at all during this five-year period he or she will fully recognize all gain on the sale. If the military member has used the house for a period of less than two years during the five-year period, the excludible amount will be reduced. This is so even where the military member was transferred before occupying the house for two years, has been assigned overseas, has occupied government quarters, or has rented another house due to the logistical requirements of the assigned duties.

The inability of the military member to qualify this residence as a "principal residence" under I.R.C. §121 eliminates the parity with other taxpayers enjoyed under the former I.R.C. § 1034 rollover provisions and imposes a tax disadvantage on the highly transient military members.

Our proposed modification removes this harsh result by suspending the running of the five-year period whenever a military member serves at a duty station that is at least 50 miles from such property or is under official orders to reside in government quarters.

We recommend incorporating into the proposed Treasury Regulation a modification that would suspend, for time spent away from home due to official extended duty, the five-year period during which the ownership and use requirements of I.R.C. § 121 must be met for service members. The proposed modification follows.

Section 1.121-4(d). Special Rule For Members Of Uniformed Services In Determining Exclusion Of Gain From Sale Of Principal Residence.

(1) In general. The running of the 5-year period described in I.R.C. section 121 shall be suspended with respect to an individual during any time that such individual or such individual's spouse is serving on qualified official extended duty as a member of the uniformed services.

(i) Qualified official extended duty. The term `qualified official extended duty' means any period of extended duty as a member of the uniformed services during which the member serves at a duty station that is at least 50 miles from such property or is under official orders to reside in government quarters.

(ii) Uniformed services. The term `uniformed services' has the meaning given such term by section 101(a)(5) of title 10, United States Code, as in effect on the date of the enactment of these regulations.

(iii) Extended duty. The term `extended duty' means any period of active duty pursuant to a call or order to such duty for a period in excess of 90 days or for an indefinite period.

The incorporation of this proposed modification to treat periods of absence due to military service as "use" would allow military members to leave their home, serve their country, and not face the possibility of a large capital gain upon selling their home. It reestablishes the parity that existed between military members and other taxpayers under the former I.R.C. § 1034.

Very Respectfully,

David C. Hague
Brigadier General
U. S. Marine Corps, Retired
Chair, Standing Committee on Legal Assistance for Military Personnel
American Bar Association