Section 121 Divorced Couple

[Kram BergGold]

From IRS pub
Separated or divorced taxpayers.
If you were separated or divorced prior to the sale of the home, you can treat the home as your residence if:

• You are a sole or joint owner, and
• Your spouse or former spouse is allowed to live in the home under a divorce or separation agreement and uses the home as his or her main home.

My clients are married. The wife lives in the home the husband moved out in 2014. If they get divorced in 2019 and the agreement says she gets to live in the jointly owned home and then they sell the home later in 2019 do they both get the $250,000 exclusion or does she have to live in the house for two years after the divorce agreement goes into effect?

[New York Enrolled Agent]

See if Reg. §1.121-4 answers the question.

[dtlee]

I think the general rule that both must own and use the property as their principal residence for at least two years during the five years before the sale has an exception under §121(d)(3)(B):

Solely for purposes of this section, an individual shall be treated as using property as such individual’s principal residence during any period of ownership while such individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in section 71(b)(2)).

This is echoed similarly under 1.121–4(b)(2) which says:

A taxpayer is treated as using property as the taxpayer’s principal residence for any period that the taxpayer has an ownership interest in the property and the taxpayer’s spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in section 71(b)(2)), provided that the spouse or former spouse uses the property as his or her principal residence.

I am wondering how others interpret this in the scenario Kram identified. A couple gets divorced in 2019 but he moved out in 2014. It seems to me that only the period of time after the divorce decree (and before the sale) would be treated as a time when the the ex-husband's spouse was granted use of the property under a divorce or separation agreement. In other words, unless the initial absence was at the time considered temporary for some reason and/or unless there was a court-decreed separation agreement prior to the divorce, it appears that this is an example where she will meet the residence use test but he will not.