Married Couple Partial Capital Gains Exclusion

[rockstoclimb]

Home sale capital gains exclusion - I bought a house (#1) in August 2017. I moved out in bought a house (#2) with my now husband in November 2022. We married in May 2023. I rented out house #1 for a year and then sold it in Dec 2023. We submitted taxes as married filing jointly for 2023, and claimed the house as a primary sale, excluding around ~200k of capital gains on the sale of the house. Husband never owned the house, or was on the mortgage or the deed, and was not required to participate in the sale of the home at all.

We're now under contract for house #3, and plan to sell house #2. Under ordinary circumstances, we understand we'd want to wait to sell until November 2024 to qualify for capital gain exclusion of up to 500k. But since one of us sold a house as primary in Dec 2023, does that disqualify us entirely until Dec 2025? Or are we eligible for a partial exclusion (up to 250k?) in Nov 2024 as my husband would meet all the requirements, but I wouldn't?

In Fairfax county Virginia if that matters at all.

[Opus 17]

Your spouse could never use their exclusion on the sale of house #1 since they did not use #1 as their main residence for 2 years.  Therefore, any exclusion you claimed in 2023 was only your personal exclusion.

If you bought #2 together in November 2022, and moved in together in 2022, then neither of you qualifies for any exclusion if you sell before November 2024, because (regardless of #1), neither of you have owned #2 and lived in it as your main home for more than 2 years.  

If you sell after November 2024, you both meet the 2 year out of 5 year rule, but you are disqualified because you used your exclusion in December 2023.   This disqualifies both of you if you file a joint return.  There are some special rules for divorce, separation, and military service, and there are special rules if two people marry and then sell homes they previously owned individually.  But that does not apply here, so I believe that your spouse can't use their "half" of the exclusion on a joint return.

If you need to sell before December 2025, you have three options.

A. Sell #2, and file as married filing separately.  Each of you reports half the capital gain (half the purchase price, half the improvements, and half the selling price).  Your spouse can claim the exclusion on their half, but you can't, so you pay capital gains tax on your half.   Note that filing separately can be a disadvantage for other reasons because certain tax benefits are reduced or disallowed when filing separately.  

B. Sell #2, file jointly, and use the full $500,000 exclusion.  Then file an amended return for 2023 to remove the exclusion and pay capital gains tax on the sale of #1.  That way, you are not disqualified for the sale of #2.

C. If the reason you are moving is due to a financial hardship as described in publication 523, you can claim a partial exclusion.  In this case, if you sold in November 2024 (11 months after you previously used the exclusion), you would qualify for a maximum exclusion of 11/24th x $500,000 = $229,000.

https://www.irs.gov/pub/irs-pdf/p523.pdf

[rockstoclimb]

Thank you so much for the detailed and comprehensive answer!

You stated:
“… there are special rules if two people marry and then sell homes they previously owned individually.  But that does not apply here…”

why doesn’t that apply here?  I owned my home individually, we got married, I sold it. Is it because my husband did not ALSO sell a home that he owned independently after we were married?

[Opus 17]

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@rockstoclimb wrote:

Thank you so much for the detailed and comprehensive answer!

You stated:
“… there are special rules if two people marry and then sell homes they previously owned individually.  But that does not apply here…”

why doesn’t that apply here?  I owned my home individually, we got married, I sold it. Is it because my husband did not ALSO sell a home that he owned independently after we were married?

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Yes, if your spouse had owned a home and sold it after the marriage, where you did not meet the residency rule, he would be able to claim his individual $250,000 exclusion.  However, because this is a joint marital home, I don't see any wiggle room that would allow him to claim an individual exclusion on a joint return.  (As I explained, he could claim an individual exclusion on half the gain if you filed separate returns, but that has drawbacks and should be carefully evaluated.)