In order to not pay taxes on your home, you must meet a few requirements. For example, you must have owned the home for at least two years during the five years prior to the date of your sale. If you lived in a house for a decade as your primary residence, then rented it out for four years before you sold the home, for example, you would still qualify.
You must have used the home you are selling as your primary residence for at least 2 of the 5 years before the date of the sale. Even if you don’t meet these requirements, there are other ways that may allow you to claim either the full exclusion or a partial exclusion. One example is if you acquire ownership of a home as part of a divorce settlement.
To meet the use requirement, you are allowed to count short temporary absences as time lived in the home, even if you rented the home to others during these absences. If you or your spouse is granted use of a home as part of a divorce or separation agreement, the spouse who doesn’t live in the home can still count the days of use that the other spouse lives in that home. This can come into play if one spouse moves out of the house, but continues to own part or all of it until it is sold.
If either spouse dies and the surviving spouse has not remarried before the date the home is sold, the surviving spouse can count the period the deceased spouse owned and used the property toward the ownership-and-use test.
Veterans can actually choose to have the five year test period for ownership and use suspended for up to ten years during any period you or your spouse serve on “qualified official extended duty” as a member of the uniformed services, Foreign Service or the federal intelligence agencies. See: Capital Gains and Your House Sale.
A reduced exclusion is available if you sell your house before passing those tests because of a change of employment, health reasons, or because of other unforeseen circumstances.
Would it ever make sense to turn down the government‘s generosity and not claim the exclusion? Well, paying tax on a home sale can make sense if it preserves the exclusion to protect more profit on another home that you plan to sell within two years.