Rev. Rul. 76-541

Advice has been requested whether, under the circumstances described below, the nonrecognition provisions of section 1034 of the Internal Revenue Code of 1954 apply to the gain realized from the separate sale of land included in a parcel contiguous to a principal residence sold by an individual taxpayer. The taxpayer owned and resided in a house situated on an undivided parcel of land containing 10 acres. The entire 10-acre parcel was used as a part of the taxpayer's principal residence. In early 1975, the taxpayer sold the house and three acres of land immediately surrounding the house. The boundaries of the three acres were established by survey, but the 7-acre portion of the original parcel was not divided. The taxpayer also attempted to sell a part of the 7-acre portion along with the three acres, but such attempt was unsuccessful.

A few weeks after the sale, the taxpayer began construction of a house on the remaining 7-acre portion to be used as a new principal residence. The house was completed and occupied by the taxpayer in late 1976.

Prior to the end of 1975, the taxpayer sold two acres of the 7-acre parcel to another purchaser. At no time was any portion of the ten acres held by the taxpayer for investment or for use in a trade or business.

The taxpayer realized a gain from each of the sales transactions. The taxpayer combined the gain from the sale of the old residence and three acres of land with the gain from the sale of the two-acre parcel and treated all such gain as gain from the sale of the old residence. The cost of constructing the new residence exceeded the total adjusted sales price of the combined properties and the taxpayer applied the nonrecognition provisions of section 1034 of the Code to all gain realized from the sales.

Section 1034(a) of the Code provides, in part, that if property used by the taxpayer as a principal residence is sold by the taxpayer, and within a period beginning 18 months before the date of such sale and ending 18 months after such date, property is purchased and used by the taxpayer as a principal residence, gain (if any) from such sale shall be recognized only to the extent that the taxpayer's adjusted sales price of the old residence exceeds the taxpayer's cost of purchasing the new residence.

Section 1034(c)(2) of the Code provides, in part, that a residence any part of which was constructed or reconstructed by the taxpayer shall be treated as purchased by the taxpayer.

Section 1034(c)(5) of the Code provides, in part, that in the case of a new residence the construction of which was commenced by the taxpayer before the expiration of 18 months after the date of the sale of the old residence, the period specified in section 1034(a) shall be treated as including a period of two years beginning with the date of the sale of the old residence.

In Bogley v. Commissioner, 263 F.2d 746 (4th Cir. 1959), reversing 30 T.C. 452 (1958), individual taxpayers acquired thirteen acres of land in 1939 and constructed a residence in which they lived until December 1, 1950, when they moved into a new residence located several miles from the old residence. Prior to December 31, 1950, the taxpayers sold the old residence and three acres of land. The remaining ten acres were sold in 5-acre parcels in June and August of 1951. The United States Court of Appeals reasoned that the thirteen acres intact were part of the taxpayers' old residence and that the character of the remaining ten acres did not change. Thus, the Court held that the gain realized from the sale of the ten acres in June and August of 1951 was entitled to the benefit of the nonrecognition provisions of section 112(n)(1) of the Internal Revenue Code of 1939 as added by section 318(a) of the Revenue Act of 1951. However, since section 112(n)(1) (the predecessor of section 1034 of the 1954 Code) applied only with respect to residences sold after December 31, 1950, the taxpayers were required to report gain and pay capital gain tax attributable to the sale of the house and three acres.

In the instant case, before the sale of the 3-acre portion, the original parcel of 10 acres was the taxpayer's "old principal residence." As in Bogley, the fact that the taxpayer sold the 3-acre portion of the property on which the house was located prior to selling the two acres of the remaining seven acres of land does not alter the character of the two acres. The 2-acre portion remains part of the taxpayer's "old principal residence" for the length of the replacement period, despite the fact that the taxpayer constructed and occupied a "new principal residence" on the adjacent five acres.

Since the new principal residence was constructed rather than purchased, under section 1034(c)(5) of the Code the taxpayer's replacement period is two years beginning with the date of the sale of the 3-acre parcel of land containing the taxpayer's old principal residence. The subsequent separate sale of the 2-acre parcel of land does not cause a new replacement period to begin.

Accordingly, the nonrecognition provisions of section 1034 of the Code apply to the gain realized from the sale of the 3-acre parcel of land containing the taxpayer's house, and also to the gain realized from the separate sale of the 2-acre parcel of land.

Rev. Rul. 56-420, 1956-2 C.B. 519, is distinguishable. That Revenue Ruling holds, in part, that the benefits of section 1034(a) of the Code are inapplicable to the sale of a portion of a city lot on which a taxpayer's house was located since the property sold did not include the taxpayer's dwelling. The taxpayer did not purchase a new house but rather continued to reside in the old house.