Same principals apply, selling a 1/8 interest in a home is fundamentally the same thing as selling a condo for tax purposes. Report the sale, use Form 1116 to claim any applicable credit. And that's a good call out by the other commenter that there will likely be an FBAR filing requirement and possibly other foreign reporting requirements. The IRS has more info about foreign reporting requirements here: https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar  

Use "Other Income" adjustments to add/back out wages, not W2. (Used to be line 21, but now well hidden thanks to the Form 1040 "simplification" this year...just search "Other" and you should be able to locate the Other Income Statement. Find a blank line and enter a negative adjustment for half the wages on the wage-earners return, using a description like "Community property wages allocated to spouse (SSN: xxx-xx-xxxx)". On the spouse's return, same thing but a positive adjustment and "from spouse" instead of "to spouse" in description. Withholding is tougher because, as you've noticed you'll encounter EF errors when creating a W2 for somebody who didn't receive one. The method that seems to work best is to use the Tax Payments Worksheet (again, just search for the name). Around line 18 there's fields to enter "other withholding" for federal and state tax. Use that for the spouse's return. On the wage-earners return, you can just enter half the withholding amount on the W2 and it should be fine. That said, some preparers encounter problems with the IRS "correcting" the withholding adjustments, and sending unwanted refunds to the wage earner and demanding payment (plus a penalty) from the spouse. Use your discretion, but what some have chosen to do is leave the federal withholding alone, request a waiver of the estimated penalty for the non-earning spouse, and get a big refund for the wage earner. Not a recommendation, just an option.