Tax Implications

Very often the marital home is the most valuable asset a divorcing couple divide, particular since the IRS permits homeowners to exclude from taxes a certain amount of capital gains from the sale of a primary residence. The gain (or loss) is the selling price of the home, minus any selling expenses, minus any adjustments or improvements. 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, the couple files a joint return for the year in question and meets the IRS “own and use test.” 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. To qualify for the maximum exemption, the couple must have owned the house and lived in it and considered it their primary residence in at least two of the previous five years. The couple has three years starting from the due date of their return in the year of the sale to decide whether or not to take this exclusion. To exclude gain under the main home sale rules, a person generally must have owned and lived in the property as his or her main home for at least two years during the five-year period ending on the date of sale. If he or she has two homes and live in both of them, his or her main home is ordinarily the one lived in most of the time.

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 is related to health, change of employment or unforeseen circumstances. In this instance, you may still be entitled to claim a reduced exemption.

Moreover, the IRS requires one spouse to have met the own and use test for married couples that file a joint return. This means that if the couple is still legally married and either spouse meets the two-year requirement, then the couple can still qualify for the full $500,000 couples exemption on their joint return.

The IRS “own and use” is satisfied when the spouses legally owned the property and one spouse continues to use the home as his or her primary residence under a divorce decree or legal separation agreement. That means that as long as a person’s remains on the deed and his or her spouse lives in the home, he or she is eligible for the full capital gains tax exemption when the house.

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