Internal Revenue Code § 121 provides taxpayers with an exclusion from gross income of up to $250,000 of gain on the sale of a taxpayer’s principal residence. A married couple may exclude up to $500,000. In order to qualify for the exclusion, the residence must have been the taxpayer’s principal residence for an aggregate of 2 years or more during the 5 year period leading up to the sale. The determination of a principal residence is a question of facts and circumstances. Treasury Regulation §1.121-1. For example, where a taxpayer alternates between two different residences, only one will be considered the principal residence based on a number of factors, including but not limited to, time spent at the residence, place of employment, place of abode of other family members, address listed on tax returns, address listed on driver’s license, mailing address for bills and correspondence, location of banks and location of religious organizations.
Nonresident aliens may also take advantage of the exclusion. However, named nonresident aliens would each need to take their share of the principal residence exclusion amount on separate tax returns since nonresident aliens do not qualify to file joint returns. Practically, this means that if the gain on the sale was in excess of $250,000, each filer would need to 1) qualify to claim the principal residence exclusion on their own, and 2) file Form 1040NR U.S. Nonresident Alien Income Tax Return to claim their portion of the principal residence exclusion.
Nonresident aliens are also subject to another tax on the sale of property, under Foreign Investment in Real Property Tax Act (“FIRPTA”). For sales of a principal residence where the amount realized (generally the sales price) is less than $300,000, no withholding is required; for sales between $300,000 and $1,000,000, the rate of withholding is 10%; and for sales exceeding $1,000,000 the rate of withholding is 15%. A nonresident alien taxpayer may find themselves in a situation where s/he would qualify to claim the IRC § 121 principal residence exclusion and thereby the FIRPTA withholding on sale would exceed his/her maximum tax liability on the transaction. In such a situation, the taxpayer may request a withholding certificate from the IRS to provide to the buyer, indicating that they owe a lower rate of withholding or none at all. Since an IRC § 121 principal residence exclusion does not constitute a non-recognition provision within the meaning of FIRPTA (non-recognition provisions result in FIRPTA not applying at all), a buyer must withhold the appropriate rate unless they are provided with a withholding certificate.