What tax considerations do divorcing couples have regarding the marital home?

Let’s say a childless couple are divorcing and they are at the ’what do we do with the house’ point in their negotiations. This point can be very difficult because the house, which is the physical manifestation of the home, picks up all manner of emotional charges when a couple divorce.

In general, therefore, couples have three choices. They can 1) sell the house and split the proceeds; 2) agree to have one spouse buy out the other’s interest as part of the overall settlement; or 3) continue to own the house jointly. Each of these approaches has advantages, depending upon the situation of the divorcing couple, but in all cases both husband and wife are advised to think about the long-term consequences of their decision.

Selling the house, a very common course, raises possible tax considerations, the problems of renting versus buying, and getting a new mortgage. At the least, both parties should know the basis for the property -- the original cost, minus improvements. Under current tax laws, each spouse may exclude up to $250,000 (or $500,000 as couple) from any capital gains tax if they have lived in the house for any two of the last five years.

A buyout by one spouse requires that the house be appraised independently. In this routine, after an appraisal, some couples dividing marital property often use a property settlement note. In this arrangement, one spouse pays the other a sum for a negotiated length of time at current interest rates. The money is a division of property, so it is not taxable. The recipient does pay taxes on the interest, not the principal. The note is normally collateralized. Some divorcing couples do not like the fact that they are now in a debtor-creditor relationship.

A buyout gets one spouses name off the title, but it normally leaves his or her name on the mortgage. This may have an impact on a party’s credit rating.

Joint ownership after divorce avoids immediate tax considerations. After the divorce happens, the couple become tenants in common, which means they both own half the house. Normally, the spouses work out arrangements whereby one party, the one who stays in the house, pays the mortgage, while all other costs are split evenly. When the children finish school, the parties sell the house and split the proceeds. Some divorcing couples may not like this arrangement because it makes former spouses business partners.

If the house must be sold, the provisions of the sale should address how, when, by whom and in what manner that sale is to happen.

Each of these courses has different tax consequences, but selling the house often means a tidy sum that each will need as they begin their new lives as separate people.

On the other hand, when courts award the marital home to a custodial parent (who is often the mother), she should consider the tax consequences of 1) the sale at a later date as a single person; 2) the real estate tax consequences if the property appreciates dramatically. (This ignores all the cares and concerns associated with home ownership, which, when shared with a spouse, seem manageable and even satisfying but which can be onerous and burdensome for a single person.)

The tax consequences of selling a home can be quite complex, and can be even more so during a divorce. The IRS has a useful publication that can be obtained from its website. The publication is Tax Information on Selling Your Home, number 523. It is a good idea to read it.