According to the Internal Revenue Service, if you have a capital gain after selling your primary home, you may be entitled to a $250,000 tax exclusion on your return. In fact, if you a file a joint return with your spouse, you can exclude up to $500,000 of the return from your income. But what if you and your spouse are in the middle of a divorce but continue to live in the marital home? What happens when you make the decision to finally sell the house?
Background on Capital Gains Home Exclusion Rules
The general rule, as per the IRS, is that spouses have a right to exclude from taxes any profits made from the sale of a primary home, provided they meet two main conditions:
The married couple used the property as their primary home for two out of the last five years
The profit from the sale does not exceed $500,000
If you’re single, the rule of using the home as a primary residence for two out of the last five years still applies. The exclusion however, is slashed by half and is now only $250,000.
Of course, there are other rules on excluding home sales from taxes, but the two above are the most important ones.
What About Divorced Couples?
For divorced spouses, the key is whether one or both parties will continue to live in the home and treat it as the primary residence. If both spouses are in compliance with the home ownership rule and take advantage of it, they should be able to exclude a total of $500,000 from the profit of their sale from federal taxes if they file jointly and up to $250,000 if separately.
But things can change as the divorce progresses. If the divorce has yet to be finalized, you can still continue to file joint tax returns. Of course, you need to consider the fact that among many divorcing couples, one spouse often moves out of the home. When this happens, the clock automatically begins ticking on the residency requirement of two out of the previous five years.
Your best bet to prevent time from affecting your sale is to sell the home in the early stages of the divorce. If the divorce drags on and one spouse decides to move out, that person may no longer be eligible for the full $250,000 federal tax exclusion.
When that happens, be ready for that spouse to ask for a larger share of the marital assets during property division to cover for future taxes as the divorce is finalized.
If you plan on taking the tax exclusion, you should also remember that you can’t have taken one for another home sold in the last 24 months. In addition, if you remarry before selling your previous marital home, you may forfeit your right to qualify for the exclusion.