The IRS, in its generosity, allows you to exclude up to $250,000 in gain from the sale of your home from your annual taxable income. (Couples filing jointly get to double that sum to $500,000.) But as always, there are strings attached.
First, you've got to own and occupy your home for at least two of the last five years in order to qualify for the exclusion. Can't make that two-year time period? You may still be eligible for partial gain exclusion, so long as you had to move early for business or job reasons, health reasons, or for something the law calls "unforeseen circumstances."
Wait... what does that last part mean, exactly? Thankfully, the IRS clarified its guidelines for unforeseen circumstances as they apply to the partial gain exclusion. We now know that such circumstances include natural disasters, divorce, and twins. (No, really. Twins. I'm not making this up.) But we'll never know exactly what sort of odd or unusual circumstance might be considered "unforeseen" by the IRS until they provide additional guidance, or until some of the related issues work their way through the court system.
The IRS recently ruled on three taxpayers' cases dealing with the "unforeseen circumstances" question. While those rulings apply only to the specific taxpayer based upon the facts and circumstances of the case, and can not be used as "authority" with respect to the tax law, these decisions (called Private Letter Rulings) do give us a window into the IRS's thinking. (The following three links are all in Adobe PDF format.)
In PLR 200601009, a family was forced to move from a "dangerous neighborhood" after an assault on one of the taxpayers sent him to the hospital. In PLR 200601022, a family left their main home and moved into another home, with the intention of moving back at some time in the future. In the meantime, they decided to rent out their prior home. However, they were forced to sell their prior home when they concluded that it because it wasn't big enough to handle their growing family. Finally, in PLR 200601023, a retired couple living in an age-restricted neighborhood was forced to move because their daughter and grandchild moved back in with them, thereby violating the age restriction clause.
In all of the above cases, the taxpayers played the "unforeseen circumstances" card -- and the IRS sided with them. As noted above, these rulings can't be used as "case law" or any other type of authority. But they do tell us that the IRS is being very reasonable in their interpretation of "unforeseen circumstances" as it applies to the home sale exclusion. And that's very good news for taxpayers.
When he's not dealing with tax issues, Roy Lewis is a motivational speaker who lives in a trailer down by the river. He understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns, as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.