[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.121-3]

[Page 509-510]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.121-3  Reduced maximum exclusion for taxpayers failing to meet 
certain requirements.

    (a) In general. In lieu of the limitation under section 121(b) and 
Sec. 1.121-2, a reduced maximum exclusion limitation may be available 
for a taxpayer who sells or exchanges property used as the taxpayer's 
principal residence but fails to satisfy the ownership and use 
requirements described in Sec. 1.121-1(a) and (c) or the 2-year 
limitation described in Sec. 1.121-2(b).
    (b) through (f) [Reserved]. For further guidance, see Sec. 1.121-
3T(b) through (f).
    (g) Computation of reduced maximum exclusion. (1) The reduced 
maximum exclusion is computed by multiplying the maximum dollar 
limitation of $250,000 ($500,000 for certain joint filers) by a

[[Page 510]]

fraction. The numerator of the fraction is the shortest of the period of 
time that the taxpayer owned the property during the 5-year period 
ending on the date of the sale or exchange; the period of time that the 
taxpayer used the property as the taxpayer's principal residence during 
the 5-year period ending on the date of the sale or exchange; or the 
period of time between the date of a prior sale or exchange of property 
for which the taxpayer excluded gain under section 121 and the date of 
the current sale or exchange. The numerator of the fraction may be 
expressed in days or months. The denominator of the fraction is 730 days 
or 24 months (depending on the measure of time used in the numerator).
    (2) Examples. The following examples illustrate the rules of this 
paragraph (g):

    Example 1. Taxpayer A purchases a house that she uses as her 
principal residence. Twelve months after the purchase, A sells the house 
due to a change in place of her employment. A has not excluded gain 
under section 121 on a prior sale or exchange of property within the 
last 2 years. A is eligible to exclude up to $125,000 of the gain from 
the sale of her house (12/24 x $250,000).
    Example 2. (i) Taxpayer H owns a house that he has used as his 
principal residence since 1996. On January 15, 1999, H and W marry and W 
begins to use H's house as her principal residence. On January 15, 2000, 
H sells the house due to a change in W's place of employment. Neither H 
nor W has excluded gain under section 121 on a prior sale or exchange of 
property within the last 2 years.
    (ii) Because H and W have not each used the house as their principal 
residence for at least 2 years during the 5-year period preceding its 
sale, the maximum dollar limitation amount that may be claimed by H and 
W will not be $500,000, but the sum of each spouse's limitation amount 
determined on a separate basis as if they had not been married. (See 
Sec. 1.121-2(a)(3)(ii).)
    (iii) H is eligible to exclude up to $250,000 of gain because he 
meets the requirements of section 121. W is not eligible to exclude the 
maximum dollar limitation amount. Instead, because the sale of the house 
is due to a change in place of employment, W is eligible to claim a 
reduced maximum exclusion of up to $125,000 of the gain (365/730 x 
$250,000). Therefore, H and W are eligible to exclude up to $375,000 of 
gain ($250,000 + $125,000) from the sale of the house.

    (h) [Reserved]. For further guidance, see Sec. 1.121-3T(h).
    (i)-(k) [Reserved].
    (l) Effective date. This section is applicable for sales and 
exchanges on or after December 24, 2002. For rules on electing to apply 
the provisions of this section retroactively, see Sec. 1.121-4(j).

[T.D. 9030, 67 FR 78361, Dec. 24, 2002]