Gains exclusion on separately owned residence post-marriage

[Olivia Pool]

Hello all! I have read through the IRS documents in this subject and can’t come to a clear consensus. Here’s the situation: I and my spouse got married in our thirties and both owned a residence. We got married December 2022, never co-habitated, and I moved in to his house in January of 2023 and we rented my property. We filed our taxes jointly that year, if it matters. June of 2023 we sold his house, which remained exclusively in his name (as mine has remained exclusively in my name). I’m trying to determine if the full gain of the property can be excluded from tax, because I did not live in the home for a full two years? He well exceeds both the use and ownership requirements. Do we need to file separately so her can plain the exclusion? Or does my moving in to the house for 6 months just mean we’ll have to suck it up and pay taxes on some prorated portion of the gains? Or does the “unforeseen circumstances” clause cover a situation like a marriage and move to a larger home? 

[Nate Meeker]

@Olivia Pool @Bill B. - I just went through this with a client, it will likely get prorated (250k for him and some for you if you qualify). I would need to have a call with you to give a definite answer.

These are the 3 main tests:

1. Ownership. The taxpayer must have owned the residence for periods aggregating at least two years during the five years ending on the date of the sale or exchange [ IRC Sec. 121(a) ].

2. Use. The taxpayer must have occupied the residence as a principal residence for periods adding up to at least two years within the five-year period ending on the date of the sale or exchange [ IRC Sec.121(a) ]. Short, temporary absences are generally counted as periods of use [ Reg. 1.121-1(c) ]. However, a one-year sabbatical leave is not considered a short, temporary absence [ Reg. 1.121-1(c)(4) , Example 4]. However, certain periods of nonqualified use may preclude excluding some of the gain.

3. One Sale in Two Years. The taxpayer must not have used the $250,000 (or $500,000) exclusion for any residence sold or exchanged during the two-year period ending on the date of the current sale or exchange.

Some court cases on unforeseen circumstances:

The IRS has ruled that hostility of neighbors ( Ltr. Rul. 200601009 ), the need for a larger home to facilitate an adoption ( Ltr. Rul. 200613009 ), concern about personal safety and well-being ( Ltr. Ruls. 200615011 , 200630004 , and 200820016 ), the need to allow a child to continue in the same school district once transportation became an issue ( Ltr. Rul. 200601022), an unexpected need to provide housing for family members ( Ltr. Rul. 200601023 ), unexpected excessive noise ( Ltr. Rul. 200702032 ), the loss of home office space due to the birth of a second child in a two-bedroom condo ( Ltr. Rul. 201628002 ), the need for a bigger house for the blended family upon marriage ( Ltr. Rul. 200725018 ), and a requirement to live in government quarters ( Ltr. Rul. 200947024 ) qualify as unforeseen circumstances that entitled taxpayers to exclude a portion of the gain on the sale of their residence.