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I moved out of a house 2 years ago that turned into an AirBNB when I moved out. Now, I want to sell that house, but to avoid capital gains, I have to have lived in it for 2 out of the last 5 years. I lived in it for about 22 months, so I need to live there two more months to avoid a $30,000 capital gains tax.

Do I need to physically move in for two months while the rest of my family stays in our current house? If I did that, what's the stop them from saying, well you can't have two primary houses, so we don't believe you actually lived there.

I guess the root of my question is, how do they know I've lived there for 24 months?

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Mostly because you say so. You could be lying, you could get away with it. Or they could for some reason think that you are lying, they could investigate, and prove that you are lying (then there would be substantial negative legal consequences). It is a fairly well-guarded secret "how they know", but maybe you annoyed a person who turned you in and that started the investigation.

The IRS cannot use arbitrary beliefs as absolute proof of some proposition, as would be used when they take you to court to penalize you. They would be in the position of asserting that you did not live in that house for 2 years, and they would have to provide evidence for that claim. Simply saying "it is our policy" is not evidence, they would have to point to a concrete fact (for instance, a record of weekly ATM withdrawals from 2500 miles away). Whatever they offer as evidence, you can perhaps address that with some compelling better evidence (your record of daily video recording of you at the 7-11 near your house). It's simply a question of who has the most convincing evidence for their claim.

(I should point out that under IRS rules, "Unlike the ownership requirement, each spouse must meet the residence requirement individually for a married couple filing jointly to get the full exclusion", so there is a presupposition in the question that does not work).

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    "they would have to provide evidence for that claim": they can ask you for evidence for any reason. They don't have to have evidence. The burden of proof is on the taxpayer; it's not a criminal trial.
    – phoog
    Jan 10 at 17:51

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