Co-ownership and section 121

[Jeremy Lee]

Hi all,

Wanted to pose an interesting question for feedback:

Is there anything in IRS section 121 that speaks to the impact on holding periods when there is an increase in ownership interest in the context of a property that is co-owned? 

For example: Party A and Party B co-own a property 50/50, where only Party B resides in the property and has resided there for a decade). Party A decides to quitclaim deed their 50% ownership to Party B (lets just say as a gift). Now that Party B has retained full ownership, can they go and sell the property and qualify for the capital gains exclusions provisioned under section 121 *without* needing to reside there for at least two years?

My understanding is that if Party A fully owned this property and outright gifted it to Party B in full, Party B would definitely be required to pass the ownership and use test and live there for at least two or more years. However, I don't see where in section 121 it would address the situation I presented (which is based on the premise that co-ownership was already established and there is now an increase in one party's ownership...). 

An alternative situation to the one presented is: Party A and Party B co-own a property 50/50 and Party B decides to build an in-law unit in the back yard, which would increase their ownership interest/stake. Because that ownership interest for Party B increased with the addition of the in-law unit that was added, would that really impact the ownership/use test and holding period to where they now wouldn't be able to sell that property without incurring capital gains unless they remained there for an additional 2 years?

Thoughts?