## Facts

- David A. Gates bought the Summit Road property in Santa Barbara, California, in 1984; it contained an 880-square-foot dwelling.
- David and Christine Gates married in 1989 and lived in the original dwelling for at least two years between August 1996 and August 1998.
- In connection with an expansion/remodeling project, the taxpayers demolished the original dwelling and constructed a new three-bedroom house on the same property, completed to meet then-current building requirements.
- The taxpayers never lived in the newly constructed house.
- In April 2000, the taxpayers sold the new house and land for $1,100,000, realizing $591,406 of gain.
- The taxpayers filed their 2000 return late and did not report the gain; during examination they conceded $91,406 was taxable but claimed the remaining $500,000 was excludable under I.R.C. § 121(a).
- The IRS issued a notice of deficiency for 2000, determining a deficiency and a § 6651(a)(1) addition to tax for failure to timely file.
- The case was submitted fully stipulated under Tax Court Rule 122.

## Issues

1. Whether I.R.C. § 121(a) allows exclusion of up to $500,000 of gain when the taxpayers satisfied the two-year use requirement in a prior dwelling on the land but sold a newly constructed dwelling they never used as a principal residence.
2. Whether the taxpayers were liable for the I.R.C. § 6651(a)(1) addition to tax for late filing of the 2000 return.

## Decision

- The court held the taxpayers were not entitled to any § 121(a) exclusion for the sale because the dwelling sold had not been used by them as a principal residence for the required period.
- The court sustained the § 6651(a)(1) addition to tax because the return was filed after the extended due date and the taxpayers failed to establish reasonable cause.

## Legal Principles

- Under § 121(a), the ownership-and-use requirement applies to the property sold as the taxpayer’s principal residence; it is not satisfied when the dwelling unit sold was never actually occupied as the principal residence.
- When statutory terms are ambiguous, legislative history and related statutory provisions may be used to determine whether Congress intended the exclusion to apply only when the sale includes the dwelling used as a home.
- Statutory treatment of adjacent vacant land sold separately supports reading § 121 as focused on a residence (a dwelling used as a home), rather than land divorced from a qualifying dwelling.
- For § 6651(a)(1), once the IRS produces evidence of late filing, the taxpayer must show reasonable cause and lack of willful neglect to avoid the addition to tax.

## Conclusion

The Tax Court ruled that § 121(a) did not permit exclusion of gain from selling a newly constructed house the taxpayers never occupied, even though they had lived in a prior dwelling on the same land within the relevant period, and it upheld the late-filing addition to tax because the taxpayers did not file by the extended deadline and did not prove reasonable cause.


Gates v. Comm’r, 135 T.C. 1 (2010)