Sale of Hotel

[LBR]

A client inherited a hotel and she and her husband lived in it while their primary house was being remodeled.
The hotel is in the process of being sold. She and her husband lived in the Hotel for 2 out of five years.
The hotel was also used as a hotel business while they were living in it. Does the IRC Section 121 apply?
Because the hotel is in California, she also needs to fill out a CA form 593-C, is she subject to the 3 1/3% CA tax because it was used as a business?
Thanks

[DaveinTexas]

Interesting question

I am unsure about the CA forms so my apologies. Maybe these bits of Code Sections will guide you to your answer.

Section 121(d)(5) and Regulation Section 1.121-5(e) provide that if a taxpayer meets the ownership and use requirements with respect to only a portion of the home, then the exclusion provisions of Section 121 still apply, but only to the portion of the home with respect to which the ownership and use requirements are met.

This would mean the only portion of the hotel they may be able to exclude is the portion they treated as their home.

Also, …Congress intended the term ‘principal residence’ to mean the primary dwelling or house that a taxpayer occupied as his principal residence. Nothing in the legislative history indicates that Congress intended section 121 to exclude gain on the sale of property that does not include a house or other structure used by the taxpayer as his principal place of abode. Although a principal residence may include land surrounding the dwelling, the legislative history supports a conclusion that Congress intended the section 121 exclusion to apply only if the dwelling the taxpayer sells was actually used as his principal residence for the period required by section 121(a)."

That is all I have for now. I can't find anything on whether or not a hotel would be excluded as a dwelling but the fact remains that the portion not used for business qualifies for the exclusion. But if the hotel has 50 rooms and 1 is used as their primary residence, then they can exclude 1/50th of the gain. Might be worth further research.

[ATSMAN]

I agree with DaveinTexas on the reasoning and citation provided. One of my former clients was running a small budget motel in which 3 rooms were exclusively used by the owner and wife and his 2 kids as their primary residence. They lived on the property and except for a part time handyman all the work for the motel was done by the family. After 9/11 they sold the motel because business was down and I consulted with a CPA hired by the buyer and seller and the ratio of square footage for personal residence was used to exclude a portion of the gain.

[Roland Slugg]

Yes, part of the gain can be excluded under Code §121(a). The critical calculation will be allocating the basis and the selling price between the "dwelling" and non-dwelling portions. If it is a small hotel ... a motel, really ... with just rooms, a small lobby and maybe a swimming pool, the allocation should be relatively simple. But if the hotel had additional amenities, such as a bar, restaurant, nice lobby, housekeeping, shops, etc, then the allocation becomes much more complex.

I had clients (since deceased) who lived in a penthouse atop a five story office building for many years. The building's roof was their backyard! They sold the building about twelve years ago, and I made a similar allocation. Never heard from the IRS or FTB about it. When Donald Trump sells the Trump Tower, he will have the same issue ... he lives in the top floor penthouse, I believe.

The California withholding requirement certainly applies to this sale. I don't know if a partial exemption is available for the portion used as the sellers' residence, but I would think not. In any case I wouldn't be too concerned, because if too much is withheld, the excess will be refunded after the tax return is filed.

What I would be concerned about, however, is making sure that the California withholding is not way, WAY, WAYYY overwithheld. The withholding rules allow for withholding based on the highest tax rate applied to the estimated gain on the sale. If this is significantly less that the "standard" 3.33% amount, there is a form the seller can submit to the escrow agent to make it so.

Here's a link you may find helpful: https://www.ftb.ca.gov/forms/2014/14_593bk.pdf