Understanding Taxes While Selling a Home During a Divorce

  • Internal Revenue Code 1041 is the root of the capital gains tax.
  • Capital gains tax includes paying taxes on the profits of selling the family home during a divorce.
  • Many seek loopholes and financial advise, in an effort to navigate this situation.

"Seeking the advice of legal and tax professional prior to selling the home also will give you the support and resources that you need."

From a financial perspective, the act of getting a divorce can be a trigger for evaluating the assets of a couple. Through sorting through and valuing them, you can understand how much is at stake during the divorce process. It helps put income and money spent in perspective, creating a financial dialogue between the two.

One thing that needs to be kept in mind is how all of this affects taxes, especially if the divorcing couple decides to sell any type of investment or property. The tax levied on the profit of that sale is called the capital gains tax.

Understanding IRC 1041

This idea stems from a United States Supreme Court decision that stated that the transfer of appreciated property, in exchange for the release of marital rights, resulted in the recognition of gain to the transferor, according to the American Bar Association. The “Magna Carta” of this sector of tax law, Internal Revenue Code 1041 was a legislative response to this decision.

IRC 1041 states that no gain or loss is recognized on a transfer of property from a spouse or a former spouse to a spouse or former spouse, if the transfer is incident to a divorce, according to the American Bar Association. If a husband were to give the wife their marital home during a divorce or the home was awarded to a specific party, no money would be exchanged in the transaction.

Transfer regulations during a divorce

Without it falling between spouses or former spouses, IRC 1041 would only apply to the transfer to a third party if it fell within the Temporary Treasury Regulations’ three situations: If the transfer is required by the divorce or separation instrument; if the transfer to the third party is made pursuant to the written request of the nontransferring spouse or former spouse; or if the transfer is made pursuant to the written consent or notification of the transfer to the third party.

There also are stipulations as to what being incident to the divorce entails and how it applies to IRC 1041. According to the American Bar Association, IRC 1041 states that being incident to the divorce means that it either occurs no more than one year after the date on which the marriage ceases or the transfer is related to the ending of the marriage.

However, there are tax consequences when transferring properties under IRC 1041, which does not exempt spouses or former spouses. This is due to the liabilities on the property or to which the property is subject exceeding the adjusted tax basis on the property itself.

Selling and worth

Part of the complications of sorting through the finances and assets is due to their worth. Typically, the marital home and retirement-related assets have the most worth and also include the most regulations. One of which is in regards to the family home’s sale and allows qualifying taxpayers to exclude from gross income gain up to $250,000 or $500,000 for qualifying joint filers, according to the American Bar Association.

This means that gains realized on the sale or exchange of the home can be excluded once every two years, but it needs to be the principal residence of the seller. This can cause an issue if a business is being run in the home, due to a use requirement and ownership coexisting. Additionally, it needs to have been owned and lived in for two of the last five years immediately preceding the sale or exchange.

If one of the former spouses is granted use of the house under a divorce decree or separation agreement, the period of use by the party or spouse without full ownership is ascribed to the party or spouse that does. If one spouse or former spouse leaves the home and goes to live elsewhere, the time period during which the other spouse or former spouse occupies the home prior to the finalization of the divorce will not be counted toward meeting the time period requirement.

Tax planning and being prepared

With the complicated language that real estate tax law entails, the reality of a divorcing couple looking to sell their family home, can get lost in the shuffle. Many times, individuals experiencing a divorce will look to downsize in their separate respective homes, due to affordability. They look to sell their married home and split the profit of the sale. The taxes that get applied to that sale are the capital gains tax and are subjected to the rules and regulations of the IRS on that sale.

Many individuals look to focus more on tax planning during this time, in order to save money and helps to deflect the emotional aspect of the situation, according to the American Academy of Matrimonial Lawyers. Many people pursue these “loopholes” when they do not meet the “two to five year residence” rule.

According to Fox Business, the IRS provides exceptions when this rule is not met. If the sale results from either a change in employment (your new job must be 50 miles or more from your old job), specific health issues, divorce, or other unforeseen circumstances, then a proportionate exclusion is available. However, none of these apply if you haven’t lived at the home at all in the five years. This is excluding members of the armed forces, employees or volunteers of the Peace Corps., foreign services, and employees of intelligence agencies.

In learning more about the tax information necessary in selling the family home during the divorce process, you are better preparing yourself for all of the financial obligations and outcomes ahead. Seeking the advice of legal and tax professional prior to selling the home also will give you the support and resources that you need.

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