When selling their home, joint filers can shelter up to $500,000 in home-sale gains from taxes, as long as they have owned and used the home as their principal residence for at least two years during the five-year period ending on the sale date.
The home-sale exclusion is $250,000 for single filers or married individuals who file separately.
But what happens if you move out of the home due to a divorce or separation?
Strategy: Go ahead and claim the $250,000 exclusion. A new IRS ruling says you'll still qualify for the full amount as long as your former spouse used the jointly owned home as his or her principal residence for at least two out of the previous five years and you explicitly gave permission for that use in your divorce papers. If the divorce papers don't include that language, you'll lose your gain exclusion privilege after you've been out of the house for three years. (IRS IL 2005-0055)
For instance, if you moved out of the home over three years ago and the home is finally sold this year, you can pocket up to $250,000 tax-free if your spouse meets the two-out-of-five-year requirement and the permission requirement is met in your divorce papers. That can provide welcome tax relief for a spouse who has to vacate the home under difficult circumstances.