How Divorce Couples Can Split the Homeowner Tax Deduction

If you are divorced, or are divorcing, and just sold your home then filing for the tax deduction raises a few questions.   Can you file for the tax deduction if you are divorced? What happens if your ex-spouse will not agree to file your taxes together?

The purpose of this article is to provide couples a little information on the tax implications of splitting or selling a divorcing couple’s principal residence, which is often among their most valuable assets.

Couples can file “married jointly”, or “married separate”.   If you are divorced before December 31 you cannot file “married jointly”.   You must file single.  If you are divorced after December 31 you still need your spouse’s agreement to file jointly.

Add in the sale of a home and you have some tricky tax scenarios a divorce attorney will need to navigate.

The Basics of the Homeowner Deduction

An unmarried individual can sell a principal residence and exclude up to $250,000 of the gain they see from selling the marital home, which means you pay no tax on the first $250,000 in profit.  On the other hand, a married couple filing jointly can exclude up to $500,000 in profit.  Without this deduction you must pay capital gains tax on the profit earned.

To qualify for the exclusion, you must pass several tests.

  • Ownership Test: You must have owned the property for at least two years during the past five years.
  • Use Test:  You must have used the property as your principal residence for at least two years during the past five years.
  • Joint Filer Test: To claim the larger $500,000 exclusion, at least one spouse must pass the ownership test, and both spouses must pass the use test.

Splitting the Homeowner Deduction

It is not uncommon for home sales to occur either during a divorce or shortly after. In Las Vegas, home values are surging, which means the federal income tax exclusion for gains from selling a principal residence can be helpful.  However, divorcing couples must plan ahead in order to take full advantage of the capital gains exemption.

If not divorced by December 31, the IRS will consider you married for the tax year, which means the two of you will be able to exclude up to  $500,000 of home sale profit, as long your soon-to-be ex agree to file jointly. If these stars do not align, then you each can file separately.  With each spouse taking a $250,000 tax exemption against their half of the profits from the sale.

Divorced and Then Sell the Home

One spouse may have exclusive use of the home, while both spouses continue ownership of the home.  Ex-spouses can continue to co-own the home following the divorce, while only one spouse lives in the home.   A common arrangement is to finalize the divorce and agree to sell the home in the future.  With both spouses splitting the proceeds equally.

The spouse not living in the home must past the ownership test and use test to take the $250,000 deduction.   This spouse must own and use the home for two years over the last five years.  A good divorce attorney will see this issue when writing up the agreement.

With proper advanced planning, the divorce agreement will allow a spouse to occupy house for only a specified period of time.  Before this time is expired the home must be sold with the proceeds divided evenly.   Another option is to allow the spouse living in the home to refinance the home and to buy out the other spouse.