Divorce and Capital Gains on Principal Residence Sale/Photo by Karolina Grabowska from Pexels
Tax Break for Married Couples
One of the biggest tax breaks married couples get to take is the exclusion of $500,000 from taxable income upon the sale of their “principal residence”.
What is a “Principal Residence”?
A home you’ve lived in for at least 2 of the last 5 years prior to sale. (No vacation or second homes).
Why Does this Matter?
In places like California, where you can buy a house for $500,000 in 2007 and now it’s worth 1.5mil, this is a HUGE tax break! Instead of paying taxes on 1 million gains, you get to exclude the first $500,000 and only pay taxes on $500,000.
Taxable gain is the remaining of sale price, minus selling expenses, minus your adjusted “basis.”
Basis is the amount you paid for your house or the amount it cost you to build it, with some pluses and minuses for improvements.
If You Sell Together
If you and your spouse sell your house at the time you’re getting divorced, the capital gains tax applies. But you’re entitled to exclude a total of $500,000 of gain from tax if you lived there for two of the five years before the sale. (If either spouse is in the military that five-year period can be extended for up to ten years under some circumstances.) And if you bought the house less than two years ago the exclusion may be reduced.
Don’t Lose the $500,000 Exclusion in Divorce!
In divorce, don’t lose it! If you get the house in divorce and later you sell it, you are now only able to take the $250,000 exclusion as a single person.
If you bought out your spouse in the divorce, remember later when you try to sell it as a single person, you will only be able to exclude $250,000.
UNLESS you remarry. And still meet the test of “principal residence” above.
What if we continue to co-own the home?
Some couples decide to co-own after divorce, maybe until the children are grown (Duke order), or for some other reason.
Whether or not you can each take $250,000 depends on a number of factors. Are you both still planing to live there some of the time (birdnesting)? You will need to pass the “principal residence” test above.
Consult Tax Attorney
Consult tax attorney for specific requirements and rules. You can also review IRS Publication 504.