CAPITAL GAINS EXCLUSION

Is selling your family residence one of the many issues you need to address when separating or divorcing your spouse/partner? 


One of the tax issues that arises is whether or not any capital gains taxes will be due when you sell the family residence.  In her June, 2012 newsletter, Certified Financial Planner, Thea Glazer talks about the considerations and pitfalls you need to watch for.  Thea shares the following information regarding capital gains and how to exclude them:

Capital gain is the profit: difference between the total amount the seller receives and the adjusted cost basis.

Broadly speaking, adjusted cost basis includes the cost you incurred to build or buy your property plus permanent improvements less certain reductions to basis. For more detailed information, see IRS publication 523 “Selling Your Home”.   The current capital gains exclusion amounts are: $250,000 for an individual and $500,000 for married persons filing jointly.

In order to qualify for the capital gain exclusion you must meet two tests: 

1)  Ownership test:  you had to have owned your property for at least 2 of the last 5 years prior to sale; 2) Use test: you must have lived in the property as your main residence for at least 2 of the last 5 years prior to sale. 

Special rules apply for use of a property after divorce.  IRS rules provide that the use test is considered met if the "outspouse" stays on title and the "in spouse" is allowed to live in the house pursuant to a divorce or separtion agreement.  This allows the "out spouse" to tack on the length of time the "in spouse" lives in the house to meet the minimum 2 years requirement.  This allows each party to be eligible for a $250,000 exclusion of the capital gain for a total for both parties of $500,000 of excluded capital gains. 

If title is transferred to the in spouse, that spouse is only entitled to a $250,000 total capital gain exclusion.  If the "out spouse" stays on title, this could impact their credit ratios or potentially reduce their ability to purchase a new house if they have equity tied up in the family residence.  All of these factors should be investigated to determine the best approach to take when trying to limit capital gains taxes.  Be aware that only one capital gain exclusion is available every 2 years.  That means if the "out spouse" uses the exclusion for the sale of the family residence, he/she cannot use the exclusion for another 2 years for the sale of his/her current property.

Make sure you understand what your tax basis is and if any capital gains may be excluded when you are gathering the information you need to make a decision on whether to sell the family residence now, or in the future.

If you have any questions, please contact me and I would be happy to answer any further questions you may have regarding this issue.