Section 121 and marriage

[Anonymous]

My wife co owned a house with her sister as their primary residence for 2 years before we were married. She moved out and rented it for 2 years. That house sold after we were married. Earnings were less than 250k each her and sister and so when we file jointly I believe we should owe no taxes on the house and the exclusion would 250k and not 500k since I never lived there right? If we sell the house we both own together now next year can we still claim 250k exclusion since I have never sold a home?

[Critter-3]

Yes  you can use your $250K exclusion later. 

[Anonymous]

I like that! So as a couple filing jointly could technically have a 250k exclusion every year instead of 500k every other year? I was concerned that since her name is on our house as well that wouldn't work. Would only half the income count toward my exclusion then since we are both owners?

[Mike9241]

not every year because ownership and occupancy must be at least two years for the full exclusion and there is a frequency limitation: for married couples - during the 2 year period ending on the date of sale, neither spouse excluded gain from the sale of another home.  if the frequency test is not met, the allowable exclusion is limited to the sum of the amounts each spouse would be qualified to exclude if they had not been married. 

under certain conditions, a partial exclusion may be available 

by the way on your wife's sale of her old house, since it was a rental, depreciation will have to be recaptured before the $250K HSE would apply.  

[Anonymous]

Sorry, that was kind of a cynical hypothetical where I forgot about occupancy. So basically if a married couple as a couple does not meet the 2 year frequency between sales then the adorable exclusion is based on meeting the two year frequency as an individual and more a married couple, which would still allow me 250k even though my wife did used hers and her name was on both homes???

I am not sure I understand your last statement regarding the rental.

[Mike9241 · Accepted solution]

the legal workaround for the frequency test for married couples is that if each spouse owns a home that meets the ownership and use tests and each meets the frequency test - have not used the HSE in the two years ending on the date of sale of their home, each can exclude up to $250K 

"My wife co owned a house with her sister as their primary residence for 2 years before we were married. She moved out and rented it for 2 years."

assuming rental at Fair Market Value, even if to her sister, under the tax laws it should have been depreciated.  depreciation reduces her tax basis in the property.  in these cases when a personal residence that was a rental is sold for more than its tax basis, even if it meets all the exclusion rules, first the depreciation must be recaptured as section 1250 gain. then and only then is any remaining gain eligible for the HSE

if it was rented to her sister at less than FMV, then it is treated solely as a personal residence and not as a rental so no depreciation would have been allowed.

[Anonymous]

Gotcha. Thanks. The real answer is I am dumb haha and need professional help when it comes to filing so I don't screw up. Just trying to learn what I can before tax time comes and before I make big decisive like selling a house.

[Mike9241]

extremely wise. too often we see questions after the deed is done and then often all we can say in response is sorry ........