Selling the Marital Home After A Divorce 8

What You Should Know About the Tax Implications

When a couple gets divorced, one of the biggest assets they will have to split is the marital home. But what are the tax consequences of how the home is handled?

The easiest way to dispose of the home is to sell it and split the proceeds. The IRS allows homeowners meeting certain eligibility tests to exclude from their income a certain amount of capital gains from the sale of their primary residence. This “gain” (or loss) is the selling price of the home minus any selling expenses minus any adjustments or improvements made to your home. For example, if you sold your house for $250,000, you could then deduct the cost of things like commissions, legal fees and points (expenses) as well as the amount your originally paid to purchase your home and any costs for improvements (adjustments) before potentially paying any capital gains tax. Currently, the IRS allows up to $500,000 for couples and $250,000 for individuals in capital gains exemptions.

In order to qualify for the $500,000 cap, you must file a joint tax return for the year in question AND meet the “own and use test” of the IRS. If either spouse does not meet the own and use test, then the maximum exclusion allowed would be the amount that each spouse would qualify for if treated separately.

Generally, to qualify for the maximum exemption, you must have owned the home, lived in the home and considered it to be your primary residence in at least 2 of the previous 5 years. You have three years starting from the due date of your return in the year of the sale to decide whether or not to take this exclusion.

This exemption can only be claimed once every two years, calculated from the date of the sale, unless the reason for selling a second home within a two-year period was because of health, change of employment or unforseen circumstances. In this instance, you may still be entitled to claim a reduced exemption.

What if one of the spouses has moved out during the separation? The IRS only requires one spouse to have met the own and use test for married couples who file a joint return. This means that if you are still legally married and either you or your spouse meet the 2 year requirement, then you would still qualify for the full $500,000 couples exemption on your joint return.

It is also not uncommon for one party to want to remain in the family home. If the spouse wishes this to be a permanent arrangement, they can opt to “buy out” the other spouse’s interest through a re-distribution of marital assets. In general, transfer of property between spouses is not taxed so the receiving spouse would not be taxed on their gain however, the spouse being bought out would want to make sure that their name was removed from the deed and the mortgage.

To do this, the spouse remaining in the home would typically need to refinance the property in her or her name only. Failure to do so could result in collections if the spouse remaining in the home doesn’t pay the bills. You could also face capital gains taxes if your spouse decided to sell the home years later.

Another option is to allow the spouse to remain in the home until the children are grown at which time, the house will be sold and the proceeds split among the two parties.

This is the most difficult arrangement of the three as it requires both spouses to remain on the mortgage and continue making payments on the home.

As for capital gains tax in this scenario, the IRS considered the “own and use” test to have been satisfied when you legally owned the property and your spouse continued to use the home as his or her primary residence under a divorce decree or legal separation agreement. That means that as long as your name remains on the deed and your spouse lives in the home, you would be eligible for the full capital gains tax exemption when the home was finally sold unless, of course, you had already sold a home and claimed a similar exemption in the previous two years.

To avoid any tax implications, you should discuss all your options with a tax professional.

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Discussion

  • Kathryn L.

    My divorce was final April 2, 2010. I moved to Montana from Virginia in August 2009.
    My ex and I are selling the Virginia house on July 21, 2010.

    My Question: I understand that I can exempt income up to $250,000 from federal tax, but what about Montana? I will be filing state taxes in Montana in April 2011 and need to know if Montana will charge me capital gains (or whatever they are officially called) taxes on the sale of my Virginia house.

  • Melissa Paquette

    My husband and I got divorced this past year and I moved out of the house in August. In the divorce he was awarded the equity in order to pay previous taxes owed and debt. He plans to claim the house on his 2010 taxes this year b/c he was the primary income earner in the home. Is that correct or do I need to claim anything about the sale of our home as well?

  • Melissa Paquette

    If I am only claiming one child as my dependent but I have 2 children that I am paying for child care while I work, can I deduct the cost of childcare for both of them or just the one I am legally claiming as a dependent?

  • J Flory

    At finalization of my divorce in 2006 my ex-spouse remained in the marital home until it sold in 2010. Per divorce decree the marital home was to be sold and proceeds split 50/50. In 2006 I purchased a new home as my primary residence and have lived in it ever since. The ex-spouse continued to live in the original marital home until it sold in 2010, at a substantial loss from our original purchase price. Can I write off the captial loss of my 50% share of the marital home (now that it sold in 2010) due to the fact that I established my new primary residence back in 2006 in a different property that I purchased back then?

    • kay

      You probably should have gotten an appraisal of the home in 2006 (you can still look back at Assessor records to guesstimate value in 2006). That is value from which you should receive your 50%. As to whether selling at a loss is a capital loss for tax purposes, your tax preparer/accountant will know that answer.

  • Amy

    My Husband wants out of Marriage so we are trying to agree and get Dissolution. He is going to keep house but what happens if he can’t Refinance the house in his name? My name is on Mortgage too..He says all i have to do is sign a quick deed???Is that true i sign a quick deed and my name automatically gets removed?? Does he have to refinance in order to get my name off deed??
    Thanks Amy

    • kay

      A Quit Claim Deed relinquishes your right to the property but does NOT remove you from the Mortgage obligation if you are on the Loan.

  • Scott

    If there is a disagreement in naming the price on house to be sold, if the person residing in the home after the divorce is solely making payments, does he have a right to name the price? Both parties are on Deed. Husband is on mortgage. Wife refuses to take a reasonable offer for the home. Is there anything that can be done legally to allow the husband who is on the loan to set the sale price? The residence is in West Virginia. What has to be done if there is a legal right to do it?