PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

JEANNE GREENE SNOWA,
Petitioner-Appellant,

v.                                                                       No. 95-2864

COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.

Appeal from the United States Tax Court.
(Tax Ct. No. 93-9553)

Argued: April 10, 1997

Decided: August 19, 1997

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.

_________________________________________________________________

COUNSEL

ARGUED: William S. Carnell, Third Year Law Student, UNIVER-
SITY OF VIRGINIA SCHOOL OF LAW, Charlottesville, Virginia,
for Appellant. Thomas Vincent Linguanti, Tax Division, UNITED
STATES DEPARTMENT OF JUSTICE, Washington, D.C., for
Appellee. ON BRIEF: Neil L. Walters, Supervising Attorney, Erin
McCoy, Third Year Law Student, UNIVERSITY OF VIRGINIA
SCHOOL OF LAW, Charlottesville, Virginia, for Appellant. Loretta
C. Argrett, Assistant Attorney General, David I. Pincus, Tax Division,
UNITED STATES DEPARTMENT OF JUSTICE, Washington,
D.C., for Appellee.

_________________________________________________________________

OPINION

MICHAEL, Circuit Judge:

In this case we decide how § 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 § 1034(a) if the "cost" of the new house exceeds the
"adjusted sales price" of the old house. Section 1034(g) allows a mar-
ried 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 § 1.1034-1(f), assessed a deficiency against
appellant Jeanne Greene Snowa (Mrs. Snowa) on the grounds that a
taxpayer cannot use § 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 § 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 § 1034(g).1

I.

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 West-
_________________________________________________________________

1 Just as we were about to file this opinion, Congress passed (and the
President signed) a bill making significant changes in the federal tax
laws. According to press accounts, the new legislation includes changes
in the Internal Revenue Code that will expand the capital gains exemp-
tion on the sale of a principal residence. We have no occasion in this
opinion to address any provisions of the new law.

                    2
minster 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 § 1034(a). Mrs. Snowa therefore did not report her
one-half share of the capital gain on the sale of the Westminster resi-
dence 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 Caro-
lina, 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 ten-
ants by the entirety.2

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 down-
ward 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
_________________________________________________________________
2 A tenancy by the entirety is"a form of co-ownership with a right of
survivorship created when real property is conveyed to a husband and
wife and the unities of time, title, interest, and possession are observed.
The estate rests upon the doctrine of unity of the person and takes its ori-
gin from the common law where husband and wife were regarded as
one." McLeod v. McLeod, 327 S.E.2d 910, 915 (N.C. Ct. App. 1985)
(citations omitted).

                    3
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 § 1034 a taxpayer may roll over gain only to the extent the pur-
chase price of the new home exceeds the adjusted sales price of the
old home. See I.R.C. § 1034(a). Mrs. Snowa challenged the defi-
ciency, appearing pro se in the tax court. She argued that § 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 hus-
band'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 § 1034(g). The tax court
agreed with the IRS, and Mrs. Snowa appeals.

II.

It is helpful to look first at the background of§ 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. § 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,§ 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 § 1034 to ease the tax burden of moving
from one house to another.3 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. Sec-
ond, many homeowners roll over the sale proceeds into a new house,
_________________________________________________________________
3 The section was originally numbered § 112(n). It was renumbered
§ 1034 when the Code was revised in 1954. For a discussion and critique
of various actions by Congress to promote America's housing expansion
before and after World War II, see Kenneth Jackson, Crabgrass Frontier:
The Suburbanization of the United States 190-218, 231-45 (Oxford Univ.
Press 1985).

                    4
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 mort-
gage 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 § 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.4 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. 5 Section 1034, enti-
tled "Rollover of gain on sale of principal residence," reflects the leg-
islative judgment that it is not always fair to recognize taxable gain
_________________________________________________________________
4 The income tax operates in large measure as a tax on transactions. See
Marvin A. Chirelstein, Federal Income Taxation, A Guide to the Leading
Cases and Concepts 72 (7th ed. 1994). Rather than impose a tax on every
incremental accretion to economic wealth, the Code waits for an event
such as the receipt of a paycheck or the sale of stock before imposing the
obligation to pay income tax.
5 See, e.g., I.R.C.§ 109 (leasehold terminations); I.R.C. § 1031 (like
kind exchanges of tangible assets); I.R.C. § 1032 (corporation's
exchange of stock for property); I.R.C. § 1033 (involuntary conversions).
Nonrecognition applies to certain transactions where"in theory the tax-
payer may have realized gain or loss but where in fact his economic situ-
ation is the same after as it was before the transaction." Century Elec.
Co. v. Commissioner, 192 F.2d 155, 159 (8th Cir. 1951). See generally
Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income,
Estates and Gifts ¶ 44.1.1 (2d ed. 1990) ("The Code contains numerous
nonrecognition provisions covering a wide range of transactions that
have little in common except that they have elicited a legislative judg-
ment that the taxpayer's realized gain or loss should not be taxed or
deducted when the exchange or other event occurs.").

                     5
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, § 1034 makes the sale of
the old house a nonrecognition event.6

Section 1034, like most nonrecognition 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. 7
_________________________________________________________________
6 The House Report likened many sales and purchases of homes to
involuntary conversions, such as the government's condemnation of a
home to build a highway. In the early 1950s many middle class home-
owners, becoming more secure in the economic prosperity following
World War II, were moving their growing families to larger homes in the
suburbs or were relocating to take new jobs. See House Report at 1808
("In these situations the transaction partakes of the nature of an involun-
tary conversion. Cases of this [involuntary] type are particularly numer-
ous in periods of rapid change such as mobilization[for the Korean War]
or reconversion."). Of course, not all decisions to buy a new home are
"involuntary" or dictated by events outside the control of the taxpayer.
Congress nevertheless determined that limiting nonrecognition to cases
in which the taxpayer moved for specified reasons would make the stat-
ute too difficult to administer. The legislative history explains,

          This special treatment is not limited to the "involuntary conver-
          sion" type of case, where the taxpayer is forced to sell his home
          because the place of his employment is changed. While the need
          for relief is especially clear in such cases, an attempt to confine
          the provision to them would increase the task of administration
          very much.

Id. at 1809.
7 Because the value of money decreases over time, it is less burden-
some to pay capital gains taxes later rather than sooner. Furthermore,
other Code provisions may allow the gain to be avoided altogether. Sec-
tion 121 allows taxpayers of age 55 and over a one-time election to
exclude up to $125,000 of gain on the sale of a principal residence. Or,
instead of selling, if the owners pass along the home to their heirs, the
heirs receive a step up in basis under § 1014 and any prior appreciation
on the home is forever eliminated for income tax purposes. See Marvin
A. Chirelstein, Federal Income Taxation: A Guide to the Leading Cases
and Concepts 297 (7th ed. 1994).

                    6
Section 1034 also reflects a decision to subsidize home ownership,
a policy choice found frequently in the Code.8 By allowing full nonre-
cognition of gain on the sale of a principal residence if the new house
is more expensive, § 1034 encourages homeowners to buy larger
homes. The tax deferral also encourages homeowners to buy replace-
ment homes rather than rent.

Subsections (a) and (e) are the operative provisions of § 1034. Sub-
section (a) effects the nonrecognition aspect of§ 1034. It provides:

          If property (in this section called "old residence") used by
          the taxpayer as his principal residence is sold by him and,
          within a period beginning 2 years before the date of such
          sale and ending 2 years after such date, property (in this sec-
          tion called "new residence") is purchased and used by the
          taxpayer as his principal residence, gain (if any) from such
          sale shall be recognized only to the extent that the taxpay-
          er's adjusted sales price (as defined in subsection (b)) of the
          old residence exceeds the taxpayer's cost of purchasing the
          new residence.

I.R.C. § 1034(a). Therefore, if a taxpayer buys a replacement house
within two years before or two years after selling a house, gain is rec-
ognized only to the extent that the proceeds are not rolled over into
the new house. If the new house costs less than the adjusted sales
price of the old one, then the taxpayer recognizes gain up to the dif-
ference (and presumably has the cash to pay the tax). If the new house
costs more, no gain is recognized at all. Subsection (e) effects the
deferral aspect of § 1034. Section 1034(e) provides:

          Where the purchase of a new residence results, under sub-
          section (a) or under section 112(n) of the Internal Revenue
          Code of 1939, in the nonrecognition of gain on the sale of
          an old residence, in determining the adjusted basis of the
          new residence as of any time following the sale of the old
          residence, the adjustments to basis shall include a reduction
_________________________________________________________________
8 See, e.g., I.R.C.§ 42 (low-income housing credit); I.R.C. § 163(h)(3)
(deductibility of interest payments on mortgages secured by principal
residence).

                    7
          by an amount equal to the amount of the gain not so recog-
          nized on the sale of the old residence. For this purpose, the
          amount of the gain not so recognized on the sale of the old
          residence includes only so much of such gain as is not rec-
          ognized by reason of the cost, up to such time, of purchasing
          the new residence.

I.R.C. § 1034(e). The taxpayer's basis in the new house is thus
adjusted downward so that the deferred gain may be recognized when
the new house is eventually sold.

Section 1034(g) allows married taxpayers to join forces and take
advantage of nonrecognition without a complicated accounting of the
dollars contributed and received by each spouse. The only figures
needed are the total purchase price of the new home and the total
sales price of the old home (less any fixing-up expenses). Subpara-
graph (g)(1)(B) allows a taxpayer to include her spouse's cost of buy-
ing the new residence as her own. See I.R.C.§ 1034(g)(1)(B) ("the
taxpayer's cost of purchasing the new residence is the cost (to the tax-
payer, his spouse, or both)"). Subparagraph (g)(1)(A) allows a tax-
payer to include her spouse's share of the sale proceeds from the old
house as her own. See I.R.C. § 1034(g)(1)(A) ("the taxpayer's
adjusted sales price of the old residence is the adjusted sales price (of
the taxpayer, his spouse, or both)"). Assuming both spouses consent,
the built-in gain is rolled over into the new house, and the decrease
in basis is allocated between the two spouses. See I.R.C. § 1034(g)(2).9

In sum, § 1034(a) is a generous provision that encourages home
ownership and makes the sale of a home a nonrecognition event for
those who buy replacement homes instead of diverting cash to pay the
_________________________________________________________________
9 Consent of both spouses is necessary because § 1034(g) allows shift-
ing of potential gains from one spouse to another. For example, a spouse
who held the old home individually while it appreciated in value would,
in the normal course, be responsible for all of the income tax due on that
appreciation when the house is sold and the gain recognized. Upon pur-
chase of the new house and the invocation of § 1034(g), however, each
spouse's basis is decreased equally to account for the unrecognized gain,
and half of the potential gain is thereby shifted to the other spouse. See
Treas. Reg. § 1.1034(f)(3), example (1).

                    8
capital gains taxes. Section 1034(g) gives married couples a chance
to take advantage of the tax deferral by letting them join forces when
buying a new home. With this understanding of § 1034, we can turn
to Mrs. Snowa's circumstances and decide whether the section applies
to her.

III.

The issue in this case is whether a taxpayer calculating the cost of
a new home for tax purposes under § 1034 may include the amount
her spouse paid as her own "cost" even though she sold the old home
with a different spouse. When the section was drafted in 1951, it
appears that no one considered how it would apply to taxpayers who
divorce and remarry during the two-year replacement period. Based
on our reading of the Code and the relevant policy judgments built
into §§ 1034(a) and (g), we believe § 1034(g) allows the newly mar-
ried couple to be treated as a single economic unit, so Mrs. Snowa
may count Mr. Snowa's contribution as her own "cost" for purposes
of § 1034.

Mrs. Snowa wants to roll over the gain from the sale of her West-
minster house (sold with her ex-husband) into her replacement house
in Jamestown (bought with her new husband). At issue is the opera-
tion of § 1034(a), which states that gain shall be recognized only to
the extent that the taxpayer's "adjusted sales price" exceeds the tax-
payer's "cost." I.R.C. § 1034(a). The IRS does not dispute that Mrs.
Snowa's adjusted sales price is her one-half share of the proceeds
from the sale of her old residence ($178,056). The IRS disagrees,
however, with Mrs. Snowa's argument that under § 1034(g) her "cost
of purchasing the new residence" is the entire purchase price of the
new residence ($180,668).

The IRS contends that Mrs. Snowa's cost is only one-half of the
purchase price of the new residence ($90,334). Regulation § 1.1034-
1(f) states that subsection (g) applies only if both houses were used
as principal residences by the "taxpayer and his same spouse." Treas.
Reg. § 1.1034-1(f) (emphasis added). Mr. Snowa and Mr. Spivey are,
of course, not the same spouse. Mrs. Snowa argues, however, that the
regulation is an impermissible interpretation of the statute and is not
a proper exercise of the Treasury's authority to interpret the Code.

                    9
The IRS has issued no revenue rulings on this issue, and no cases in
this circuit or elsewhere address the validity of Treasury regulation
§ 1.1034-1(f). We explain below why we agree with Mrs. Snowa that
the "same spouse" requirement of Treasury regulation § 1.1034-1(f)
is invalid.

A.

The Supreme Court has set forth a two-step process to guide judi-
cial review of an agency regulation that construes a statute. First, we
must determine whether the statute directly addresses the precise
issue before us. "If the intent of Congress is clear, that is the end of
the matter; for the court, as well as the agency, must give effect to the
unambiguously expressed intent of Congress." Chevron U.S.A. Inc. v.
Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43
(1984); see also United States v. Jefferson-Pilot Life Ins. Co., 49 F.3d
1020, 1022 (4th Cir. 1995). Second, if the statute is silent or ambigu-
ous in expressing congressional intent, we must determine whether
the agency's interpretation is based on a "permissible construction of
the statute." Chevron, 467 U.S. at 843; see also Jefferson-Pilot, 49
F.3d at 1022.

In applying the first step of the Chevron analysis, we conclude that
§ 1034(g) is ambiguous on the issue presented in this case. Paragraph
(g) provides in relevant part:

          (g) Husband and wife.

           If the taxpayer and his spouse, in accordance with regula-
          tions which shall be prescribed by the Secretary pursuant to
          this subsection, consent to the application of paragraph (2)
          of this subsection, then--

          (1) for purposes of this section--

           (A) the taxpayer's adjusted sales price of the old
          residence is the adjusted sales price (of the tax-
          payer, or of the taxpayer and his spouse) of the
          old residence, and

                     10
           (B) the taxpayer's cost of purchasing the new
          residence is the cost (to the taxpayer, his spouse,
          or both) of purchasing the new residence
          (whether held by the taxpayer, his spouse, or the
          taxpayer and his spouse); and

          (2) so much of the gain on the sale of the old resi-
          dence as is not recognized solely by reason of this
          subsection, and so much of the adjustment under
          subsection (e) to the basis of the new residence as
          results solely from this subsection shall be allo-
          cated between the taxpayer and his spouse as pro-
          vided in such regulations.

          This subsection shall apply only if the old residence and the
          new residence are each used by the taxpayer and his spouse
          as their principal residence.

On its face, paragraph (g)(1) seems to allow exactly what Mrs. Snowa
needs: to use her share of the proceeds from the sale of the old resi-
dence as the "adjusted sales price" and to use both her share and Mr.
Snowa's share of the cost as the "cost of purchasing the new resi-
dence." By italicizing the words that apply to Mrs. Snowa and her
current spouse and by adding some language for clarification, we see
how paragraph (g)(1) operates, according to her:

          If the taxpayer and [her] spouse [consent to the decrease in
          basis, then] (1)(A) the taxpayer's adjusted sales price of the
          old residence is the adjusted sales price (of the taxpayer, or
          of the taxpayer and [her] spouse) of the old residence, and
          (B) the taxpayer's cost of purchasing the new residence is
          the cost (to the taxpayer, [her] spouse, or both) of purchas-
          ing the new residence (whether held by the taxpayer,[her]
          spouse, or the taxpayer and [her] spouse )[.]

I.R.C. § 1034(g) (emphasis added). Mrs. Snowa does not have to
stretch the meaning of any of the words of paragraph (g)(1). Mrs.
Snowa is the "taxpayer" and Mr. Snowa is her"spouse;" the "tax-
payer" and her "spouse" consented; the adjusted sales price of the
Westminster residence is the adjusted sales price of the "taxpayer";

                    11
and the cost of the Jamestown residence is the cost to "both" the tax-
payer and her spouse. Mrs. Snowa fits within the operative language
of § 1034(g).

The IRS does not dispute Mrs. Snowa's reading of paragraph
(g)(1), but it points to the flush language10 that follows, which states,
"This subsection [g] shall apply only if the old residence and the new
residence are each used by the taxpayer and his spouse as their princi-
pal residence." I.R.C. § 1034(g). This sentence, the IRS argues, sug-
gests that the taxpayer must be married to the same spouse when both
buying the new residence and selling the old residence. The sentence
refers to a "taxpayer and his spouse," not a "taxpayer and his spouses"
or a "taxpayer and a spouse." Mrs. Snowa still might fit into the stat-
ute, however. Each residence was lived in by the taxpayer (Mrs.
Snowa) and her spouse, albeit a different spouse in each. The statute
is therefore ambiguous.

Because Congress has not spoken directly to the issue, we must
turn to step two of the Chevron analysis and consider whether the
Treasury's interpretation is based on a permissible construction of the
statute. See Chevron, 467 U.S. at 845; Jefferson-Pilot, 49 F.3d at
1022. Regulation § 1.1034-1(f) provides in relevant part, "Such con-
sent may be filed only if the old residence and the new residence are
each used by the taxpayer and his same spouse as their principal resi-
dence." Treas. Reg. § 1.1034-1(f)(1) (emphasis added). This regula-
tion, unlike the flush language in the statute, clearly requires that the
taxpayer must live in both residences with the same spouse. The regu-
lation does not explain why it interprets the statute as excluding tax-
payers who remarry during the two-year replacement period.

Our standard of review in determining whether an agency's regula-
tion is valid depends on whether the regulation is legislative or inter-
pretive. A regulation promulgated in the following circumstance is
legislative: "If Congress has explicitly left a gap for the agency to fill,
_________________________________________________________________
10 The phrase "flush language" refers to language that is written margin
to margin, starting and ending "flush" against the margins. Flush lan-
guage applies to the entire statutory section or subsection, in this case
subsection 1034(g). See Reser v. Commissioner , 112 F.3d 1258, 1262
n.10 (5th Cir. 1997).

                     12
there is an express delegation of authority to the agency to elucidate
a specific provision of the statute by regulation." Chevron, 467 U.S.
at 843-44. Legislative regulations are to be given"controlling weight
unless they are arbitrary, capricious, or manifestly contrary to the stat-
ute." Id. at 844. Interpretive regulations, on the other hand, clarify
ambiguous terms found in the statute or explain how a provision oper-
ates. Interpretive regulations are accorded "considerable weight," id.,
and should be upheld if they implement the congressional mandate in
a reasonable manner. National Muffler Dealers Ass'n, Inc. v. United
States, 440 U.S. 472, 476 (1979); Schuler Indus., Inc. v. United
States, 109 F.3d 753, 754 (Fed. Cir. 1997). See also Reich v. New
York, 3 F.3d 581, 586 (2d Cir. 1993) ("[T]he respect accorded the
Secretary's interpretive regulations depends upon their persuasive-
ness; and we will accept that interpretation to the extent it assists us
in applying the statute and the legislative rules.") (citing pre-Chevron
cases).

The IRS argues that Treasury regulation § 1.1034-1(f) is a legisla-
tive regulation and that the same spouse requirement must be given
controlling weight. We disagree. Congress left a gap in the statute
concerning how to file consent, and Congress directed the agency to
fill that gap. It did not, however, leave an explicit gap in the statute
as to who may qualify as a spouse. Section 1034(g) begins, "If the
taxpayer and his spouse, in accordance with regulations which shall
be prescribed by the Secretary pursuant to this subsection, consent to
the application of paragraph (2) . . . ." I.R.C.§ 1034(g). The IRS
argues that this language gives the Secretary of the Treasury "respon-
sibility for interpreting" § 1034(g). Brief for Appellee at 46. This
argument overstates the delegation of rulemaking authority here. The
statutory language at the beginning of § 1034(g) instructs the Trea-
sury to promulgate regulations outlining the administrative require-
ments a taxpayer and spouse must comply with to file their consent
to the allocation of the decrease in basis. Consent is necessary
because, when the basis in the new home is adjusted downward, part
of the taxpayer's deferral becomes the spouse's future taxable gain.
Congress instructed the Treasury to come up with rules ensuring that
each spouse consents and delegated the authority to determine how,
when, and where the form acknowledging consent must be filed. See
Treas. Reg. § 1.1034-1(f)(2) ("Such consent shall be filed with the
district director with whom the taxpayer filed the return for the tax-

                     13
able year or years in which the gain from the sale of the old residence
was realized."); I.R.S. Form 2119 (Sale of Your Home). Congress did
not, however, delegate the power to determine who gets to file for
consent to the allocation of basis. That determination was made by
Congress in the statutory language, "taxpayer and his spouse." Thus,
Treasury Regulation § 1.1024-1(f)(1), which imposes the same spouse
requirement, is not a legislative regulation, and we do not accord it
controlling weight.

B.

The regulation is still entitled to considerable deference. The Secre-
tary of the Treasury has the general authority to promulgate "all need-
ful rules and regulations for the enforcement of" the Internal Revenue
Code. I.R.C. § 7805(a). Treasury regulation§ 1.1034-1(f) interprets
the flush language of § 1034(g), and like any other interpretive regu-
lation must be given considerable weight. Specifically, we must defer
to Treasury regulation § 1.1034-1(f) if it"implements the congressio-
nal mandate in a reasonable manner." National Muffler, 440 U.S. at
476 (1979); see Chevron, 467 U.S. at 844 (stating that in the case of
an interpretive regulation "a court may not substitute its own con-
struction of a statutory provision for a reasonable interpretation made
by the administrator of an agency") (emphasis added). For the reasons
that follow, we conclude that the "same spouse" requirement does not
implement the congressional mandate in a reasonable manner, and we
agree with Mrs. Snowa that a taxpayer need not be married to the
same spouse to take advantage of § 1034(g).

The congressional aim behind § 1034(g) was to treat family
finances as being run from a single pocketbook. This was necessary
to ease the burden married taxpayers face when buying a replacement
home. Thus, § 1034(g) allows a married couple to join forces when
buying a home without worrying about who pays for the new house,
who signs the mortgage note, or who held title to the old house under
state law.11 All Mrs. Snowa wants to do in this case is take advantage
_________________________________________________________________
11 See Boris I. Bittker & Lawrence Lokken, Federal Taxation of
Income, Estates and Gifts ¶ 44.5.2 (2d ed. 1990) (noting that § 1034(g)
"allows a married couple to combine forces in applying § 1034. . . .

                    14
of the single family pocketbook principle by including in her own
"cost" the amount paid by Mr. Snowa with cash or loan proceeds. We
believe the language of § 1034(g)(1)(B) allows her to do this. See
I.R.C. § 1034(g)(1)(B) ("the taxpayer's cost of purchasing the new
residence is the cost (to the taxpayer, his spouse, or both) of purchas-
ing the new residence (whether held by the taxpayer, his spouse, or
the taxpayer and his spouse)").

The legislative history suggests that the Treasury's authority in
implementing § 1034(g) is limited to treating the family pocketbook
as a single unit:

          Regulations will be issued under which the taxpayer and his
          spouse acting singly or jointly may obtain the benefits of
          [§ 1034] even if the spouse who sold the old residence was
          not the same as the one who purchased the new one, or the
          rights of the spouses in the new residence are not distributed
          in the same manner as their rights in the old residence.

House Report at 1810. Congress thus directed the Treasury to write
permissive regulations allowing spouses to roll over the gain regard-
less of the form of the transaction, not restrictive regulations narrow-
_________________________________________________________________
[G]ain on a sale of an old residence by either spouse qualifies for nonre-
cognition even if the new residence is purchased by the other spouse[.]").
By allowing a married taxpayer to include her spouse's cost as her own,
§ 1034(g) allows full rollover of gains even if her individual "cost" (the
amount of cash and debt actually contributed to the purchase) does not
exceed her "adjusted sales price" (sale proceeds she would be deemed to
receive from the sale of the old house under state law). Section 1034(g)
thus provides a legislative exception to the general rule that a taxpayer
cannot recharacterize a transaction to avoid the tax consequences of the
form of the transaction actually chosen. Compare Signet Banking Corp.
v. Commissioner, ___ F.3d ___, slip op. at 5 (4th Cir. July 8, 1997) (stat-
ing general rule that "`while a taxpayer is free to organize his affairs as
he chooses, nevertheless, once having done so, he must accept the tax
consequences of his choice, whether contemplated or not, and may not
enjoy the benefit of some other route he might have chosen to follow but
did not.'") (quoting Commissioner v. National Alfalfa Dehydrating &
Milling Co., 417 U.S. 134, 149 (1974)).

                    15
ing the definition of spouse. The House Report continues, "These
regulations will apply only if the spouses consent to their application
and both old and new residence are used by the taxpayer and his
spouse as their principal residence." Id. This sentence indicates that
Congress only wanted to place two restrictions on the family pocket-
book principle. First, as discussed earlier, there is the "consent"
requirement to ensure that both spouses agree on the decision to roll
over the gain. Second, there is a "principal residence" requirement in
the flush language which prevents taxpayers from rolling over the
gain from a vacation home into a new residence. We believe, there-
fore, that the flush language the IRS relies on so heavily has nothing
to do with the definition of "taxpayer and his spouse." The Treasury's
same spouse requirement conflicts with the family pocketbook princi-
ple and is not a valid exercise of the Treasury's authority to interpret
the Code.

Tax policy considerations confirm that excluding taxpayers who
remarry within the two-year replacement period conflicts with the
congressional mandate. Remarried taxpayers and their children need
adequate homes as much as anyone else. If remarried taxpayers are
allowed to take advantage of § 1034(g), it gives them a better chance
to buy a new house and to establish as soon as possible a stable home
environment for children joining them from a prior marriage. But the
Treasury's "same spouse" exclusion may force divorced parents who
remarry to buy a smaller home or rent so that they have the cash to
pay the capital gains tax on the sale of a house owned with a former
spouse. This exclusion of remarried taxpayers cannot be what Con-
gress had in mind when it said that the old home and the new home
must each be used by the "taxpayer and his spouse" as a principal res-
idence. I.R.C. § 1034(g) (flush language).

State property law also supports Mrs. Snowa's construction of the
statute. Mrs. Snowa overstates her case a bit, arguing that because she
holds title to the Jamestown residence as a tenant by the entirety (and
thus holds an undivided interest in the property), the entire cost of the
property is her "cost" for purposes of § 1034(a). Her theory does not
make sense under subsection (a) alone, because it would create a
windfall capital loss on the subsequent resale of the home.12 Both Mr.
_________________________________________________________________
12 Suppose each spouse has a "cost" of $180,000 and a corresponding
cost basis of $180,000. Mrs. Snowa correctly observes that she would not

                    16
and Mrs. Snowa contributed some money to the purchase, but the fic-
tion of property law which tells us that they each hold an undivided
interest does not mean that they each paid $180,000 for a single
$180,000 home. Nevertheless, the fact that the Snowas hold the prop-
erty as tenants by the entirety under state law does support the argu-
ment that subsection (g) applies. The Snowas each hold an undivided
interest in the property, which may have encouraged them to pay for
it together. Subsection (g), entitled "Husband and Wife," encourages
this sort of joint marital purchase. It presumes that a married couple
acts together as one financial unit and allows a spouse to include the
other's cost as his or her own.

The IRS admits that if Mrs. Snowa had simply structured the trans-
action differently, she could have been responsible for the whole
"cost" under § 1034(a) and would not have to rely on § 1034(g). For
example, she could have paid the entire balance from a separate bank
account and had her husband guarantee the mortgage note instead of
co-signing. Requiring such technical structuring would add another
layer of complexity to buying a home, which is complicated enough
as it is. We believe the IRS's suggestion that Mrs. Snowa should have
structured the transaction differently is misguided. Congress enacted
§ 1034(g) to encourage married couples to pay for new homes
together and to relieve them from exactly this kind of complex and
needless maneuvering.13
_________________________________________________________________

recognize gain under § 1034(a) because the cost of the new house
exceeds her share of the adjusted sales price of the old house. Without
a further adjustment, however, a basis problem arises which would give
Mrs. Snowa a windfall capital loss in the future. If the new house is
resold for its purchase price of $180,000 and each spouse receives half
the sales proceeds, each spouse would receive a $90,000 capital loss
($180,000 - $90,000), less the amount of gain rolled over from the old
home under § 1034(e). Section 1034(g) allows each spouse to use a
"cost" of $180,000, but solves the basis problem by requiring spouses to
allocate the cost basis between them. See I.R.C. § 1034(g)(2), clause 2;
Treas. Reg. § 1.1034-1(f)(3), example (1).

13 We note that more recent amendments to § 1034(g) suggest that Con-
gress intended "taxpayer and his spouse" to be interpreted broadly. In
1988 Congress added a sentence at the end of § 1034(g) which provides

                    17
We hold, therefore, that a taxpayer who has divorced and remarried
may take advantage of § 1034(g) and need not have lived in both the
old home and the new home with the same spouse. Mrs. Snowa
resided in both her old residence and new residence with her "spouse"
even though the spouse was Mr. Spivey in the old residence and Mr.
Snowa in the new one.

C.

We are mindful that courts have historically given considerable
deference to the Treasury's interpretation of the Internal Revenue
Code. See, e.g., Bob Jones Univ. v. United States, 461 U.S. 574, 596-
97 (1983); United States v. Correll, 389 U.S. 299, 307 (1967) ("The
role of the judiciary in cases of this sort begins and ends with assuring
that the Commissioner's regulations fall within his authority to imple-
ment the congressional mandate in some reasonable manner."). We do
not mean to throw that venerable practice into doubt. As we discussed
above, a Treasury regulation must be accepted as a proper exercise of
delegated lawmaking authority if the regulation fills an explicit gap
left to the agency by Congress or if the regulation interprets an ambig-
uous Code section in a reasonable manner. See Chevron U.S.A. Inc.
v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43
(1984). Some ambiguity in a statute as complex as the Internal Reve-
nue Code is inevitable. Deference to the Treasury allows that agency
to make sensible rules clarifying the Code so that taxpayers do not
have to take pot luck in the courts with every return. Correll, 389 U.S.
_________________________________________________________________
that if one spouse dies before buying a replacement home, the deceased
spouse will be deemed to consent to the allocation in basis. The IRS
argues that Congress "presumably was aware of the distinction between
an intervening death and an intervening divorce, yet it chose not to
extend the statute that far." Brief for Appellee at 44. The IRS also argues
that because the Treasury's "same spouse" requirement has been in place
since 1953, the regulation should be deemed to have received congres-
sional approval. See id. at 48. There is no reason to believe, however,
that Congress considered the issue before us. The IRS's legislative reen-
actment argument notwithstanding, we believe the 1988 amendment
relaxing the consent requirement simply confirms that Congress intends
§ 1034(g) to apply broadly to any taxpayer who wishes to include a
spouse as part of a single economic unit.

                   18
at 302. Nevertheless, the courts must retain the role of ensuring that
the Treasury operates within the proper scope of its authority. In the
unusual case when a regulation contradicts the plain meaning of the
Code or fails to implement the congressional mandate in a reasonable
manner, we cannot defer to the Treasury because that would violate
our fundamental authority and duty to say what the law is. See
Marbury v. Madison, 5 U.S. (1 Cranch) 137, 177 (1803); Henry P.
Monaghan, Marbury and the Administrative State, 83 Colum. L. Rev.
1, 26-28 (1983). This is one of those unusual cases.

D.

Because § 1034(g) applies, Mrs. Snowa may include Mr. Snowa's
cost as her own. Her cost of the new house (including Mr. Snowa's
share) is $180,688. See I.R.C. § 1034(g)(1)(B). Her share of the pro-
ceeds from the old house is $178,056. See I.R.C. § 1034(g)(1)(A).
Because the cost of the new house exceeds her share of the proceeds
from the old house, Mrs. Snowa recognizes no gain. See I.R.C.
§ 1034(a). The amount of gain not recognized is $69,518, see I.R.C.
§ 1001(a), and Mr. and Mrs. Snowa must each adjust their basis
downwards by one-half this amount ($34,759) to reflect the rollover
of gain. See I.R.C. § 1034(g)(2); Treas. Reg. § 1.1034-1(f)(3), exam-
ple (1).

IV.

We agree with Mrs. Snowa that the "same spouse" requirement of
Treasury regulation § 1.1034-1(f)(1) conflicts with the congressional
mandate and hold that a taxpayer need not live in both the old resi-
dence and new residence with the same spouse to qualify under
§ 1034(g). Mrs. Snowa is entitled to use § 1034(g) and may properly
roll over the gain from the sale of her old residence into her new resi-
dence. Accordingly, the judgment of the tax court is

REVERSED.

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