7849 / Can gain from the sale of property that was used only partly as a principal residence be excluded from income?

IRC Section 121 does not apply to the gain allocable to any portion of property that is separate from the “dwelling unit” to which a taxpayer does not satisfy the use requirement. A taxpayer is not required to allocate gain if both the residential and business portions of the property are within the same dwelling unit. Although the taxpayer must pay tax on the gain equal to the total depreciation taken after May 6, 1997, he or she may exclude any additional gain on the residence up to the maximum amount. However, if the business portion of the property is separate from the dwelling unit, the taxpayer is required to allocate the gain, and is able to exclude only the portion of the gain attributable to the residential unit.¹ The term “dwelling unit” has the same meaning as in IRC Section 280A(f)(1), but does not include appurtenant structures or other property.² The method for determining the amount of gain allocable to the residential and nonresidential portions of the property is explained in Treasury Regulation Section 1.121-1(e)(3).

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1. Treas. Reg. § 1.121-1(e)(1).

2. Treas. Reg. § 1.121-1(e)(2).

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