Appeal from the United States Tax Court.
Before WILKINS and MICHAEL, Circuit Judges, and BUTZNER, Senior Circuit Judge.
Reversed by published opinion.
Judge Michael wrote the opinion, in which Judge Wilkins and Senior Judge Butzner joined.
In this case we decide how Section(s) 1034 of the Internal Revenue Code (the Code) treats a taxpayer seeking deferral of capital gains taxes on the sale of a principal residence if the taxpayer has divorced and remarried during the two-year replacement period. Tax deferral is available under Section(s) 1034(a) if the "cost" of the new house exceeds the "adjusted sales price" of the old house. Section 1034(g) allows a married taxpayer to include in her own cost the portion of the purchase price paid by her spouse when calculating the cost of the new home for tax purposes. The Internal Revenue Service (IRS), relying on Treasury regulation Section(s) 1.1034-1(f), assessed a deficiency against appellant Jeanne Greene Snowa (Mrs. Snowa) on the grounds that a taxpayer cannot use Section(s) 1034(g) unless she used both the old home and the new home as a principal residence with the same spouse. The tax court upheld the IRS. We conclude, however, that the regulation's "same spouse" requirement fails to implement the congressional intent of Section(s) 1034(g) in a reasonable manner. Accordingly, we reverse and hold that a taxpayer need not be married to the same spouse to take advantage of Section(s) 1034(g). *fn1
Mrs. Snowa and her ex-husband, Willis Spivey (Mr. Spivey), used their jointly owned home in Westminster, South Carolina, as their principal residence until they divorced in 1989. They sold the Westminster home for $380,000 in November of that year. Mrs. Snowa's one-half share of the sale proceeds was $178,056 after expenses, and her share of the capital gain was $69,518. On Form 2119 (Sale of Your Home) included with her 1989 tax return, Mrs. Snowa indicated that she planned to buy a replacement home within the two-year period allowed by Section(s) 1034(a). Mrs. Snowa therefore did not report her one-half share of the capital gain on the sale of the Westminster residence as gross income on her 1989 return. In other words, she sought to avoid capital gains taxes for 1989 by deferring recognition of the gain.
In 1991 Mrs. Snowa married Henry Lin Snowa (Mr. Snowa). The Snowas promptly bought a house together in Jamestown, North Carolina, for $180,668. The Snowas paid for their new home with funds of their own and proceeds of an $85,000 mortgage loan. They were co-signers on the note. The Snowas live in the Jamestown home with their three children and use it as their principal residence. Under North Carolina law the Snowas hold joint title to the property as tenants by the entirety. *fn2
Mr. and Mrs. Snowa filed a joint federal income tax return for 1991. They attached Form 2119, reporting their purchase of the Jamestown house as the "replacement residence" for Mrs. Snowa's Westminster residence. Calculations on the form reflected that the Snowas sought to "roll over" or postpone Mrs. Snowa's gain on the sale of her Westminster house. The Snowas stated on the return that they agreed to adjust their basis in the new Jamestown home downward by the amount of gain Mrs. Snowa realized on the sale of the house in Westminster. The IRS rejected this treatment and sent Mrs. Snowa a notice of deficiency stating that she owed an additional $21,037 in income taxes for 1989. The IRS contended that Mrs. Snowa could not roll over the gain because her share of the cost of the new home, which the IRS deemed to be one-half of the purchase price, did not exceed her share of the proceeds from the old home. Under Section(s) 1034 a taxpayer may roll over gain only to the extent the purchase price of the new home exceeds the adjusted sales price of the old home. See I.R.C. Section(s) 1034(a). Mrs. Snowa challenged the deficiency, appearing pro se in the tax court. She argued that Section(s) 1034(g) allows her to include her current spouse's share of the purchase price of the new home as her own "cost." Calculated to include her husband's share, Mrs. Snowa's cost of the new home would exceed her share of the proceeds from the sale of the old home, and the rollover of her gain on the sale of the old home would be authorized. The IRS countered that a taxpayer who did not live in both homes with the same spouse may not take advantage of Section(s) 1034(g). The tax court agreed with the IRS, and Mrs. Snowa appeals.
It is helpful to look first at the background ofSection(s) 1034. Like the sale of any property that appreciates in value, the sale of a house can create taxable gain. Without special provisions, the seller of a house would recognize capital gain on the amount realized from the sale less the adjusted basis in the house (usually the original cost plus the cost of any improvements made). See I.R.C. Section(s) 1001(a). Tax on the capital gain can discourage the sale of a house that has appreciated in value. With respect to a principal residence, however,Section(s) 1034 provides a method for deferring the tax on any gain.
In 1951, in the midst of America's post-World War II housing boom, Congress enacted Section(s) 1034 to ease the tax burden of moving from one house to another. *fn3 Several considerations led Congress to decide that taxing the gain realized from the sale of a house is not always fair. First, inflation may cause the appreciation in value. Second, many homeowners roll over the sale proceeds into a new house, and recognizing taxable gain on the sale of the old house may force a homeowner to buy a smaller new house or take out a larger mortgage to come up with the cash to pay the capital gains taxes. Third, events such as the arrival of a baby or a change in jobs often dictate the decision to buy a new home. As the House Report for the bill enacting Section(s) 1034 explains, "[t]he hardship [of recognizing taxable gain] is accentuated when the transactions are necessitated by such facts as an increase in the size of the family or a change in the place of the taxpayer's employment." H.R. Rep. No. 586 (1951), reprinted in 1951 U.S.C.C.A.N. 1781, 1808 [House Report].
The sale or exchange of property usually triggers taxable gain or loss. *fn4 Sometimes, however, Congress adds a section to the Code that allows certain transactions to be ignored for tax purposes, deferring recognition of the gain or loss until the occurrence of a later event. The technical term for this is "nonrecognition"; it characterizes Code provisions that avoid the recognition of income for tax purposes even though the taxpayer has realized income in the economic sense of having control over the cash or property received. *fn5 Section 1034, entitled "Rollover of gain on sale of principal residence," reflects the legislative judgment that it is not always fair to recognize taxable gain on the sale of a home. Because Congress decided that buying a replacement home is not an event that deserves recognition of the appreciated value in the house that is sold, Section(s) 1034 makes the sale of the old house a nonrecognition event. *fn6
Section 1034, like most non-recognition provisions in the Code, does not provide complete tax relief. It merely defers recognition of taxable gain until a later date. Accordingly, the basis in the new house (normally its cost) is reduced by the amount of gain not recognized. The gain is therefore preserved in the decreased basis in the new house and may be recognized when that house is sold. *fn7
Section 1034 also reflects a decision to subsidize home ownership, a policy choice found frequently in the Code. *fn8 By allowing full non-recognition of gain on the sale of a principal residence if the new house is more expensive, Section(s) 1034 encourages homeowners to buy larger homes. The tax deferral also encourages homeowners to buy replacement homes rather than rent.
Subsections (a) and (e) are the operative provisions of Section(s) 1034. Subsection (a) effects the non-recognition aspect ...