Navigating Tax Troubles in Divorce: Selling or Transferring the Marital Home.
Divorce often comes with complex financial decisions during a time that is already challenging, stressful and emotional. One of the most significant assets that couples have to address is the marital home. Whether selling the home or transferring ownership to a spouse, understanding the tax implications is vital. This blog will offer some guidance that helps explain the potential tax consequences and offers some useful tips on how to alleviate them. Making informed decisions during divorce can help couples avoid financial pitfalls post-divorce.
Some Essential Guidance
Understanding Capital Gains Tax When Selling a Home in Divorce
When a property is sold, the profit is a capital gain. For a marital home, the gain is calculated by subtracting the home's original purchase price (the cost basis), any improvement costs (kitchen/bath remodel, new floors or windows, any upgrades) and realtor fees from the final selling price.
In divorce, the IRS allows a special exclusion for capital gains on the sale of a primary residence. Individuals can exclude up to $250,000 of capital gains from their taxable income while married couples filing jointly can exclude up to $500,000. Some couples may choose to use this strategy and sell the home before their divorce is finalized to benefit from the high capital gain cap.
To qualify for the exclusion, the parties must have owned and lived in the home as the primary residence for at least two of the five years prior to the sale. In divorce cases, even if one spouse moves out, they can still qualify for the exclusion as long as the other spouse continues to use the home as their primary residence.
Capital gains exclusions can significantly reduce or even eliminate the capital gains tax owed, making it a desirable feature for the division of assets in divorce settlements.
The Tax Benefits of Transferring Home Ownership to a Spouse Pursuant to Divorce
Transferring home ownership to a spouse during a divorce can have significant tax benefits as well since the transfers are generally tax-free. This means capital gains tax is not owed nor is there a gift tax on the transfer.
In order for the transfer to be tax-free, it must be part of the divorce agreement and can be done through a quitclaim deed that transfers one spouse's interest in the property to the other without selling the home.
The transfer must occur within one year after the divorce or be related to the divorce (like being part of the final divorce agreement). Whichever party is receiving the transfer must continue to use the home as their primary residence in order to retain the tax benefits and avoid future capital gains taxes.
There are some tax considerations to consider when transferring property:
The transfer needs to be documented properly in the divorce agreement to avoid any disputes or misunderstandings.
Understand any state-specific rules and make sure that the transfer complies with IRS rules by speaking with a tax advisor or attorney.
Consider future tax implications regarding potential capital gains if the receiving spouse thinks they might eventually sell the home.
Splitting Mortgage Interest and Property Tax Deductions Post-Divorce
After a divorce, both parties may still be responsible for mortgage payments and property taxes on a jointly owned home. It can help to understand how to split these deductions and making sure everything is in compliance with IRS tax laws.
When it comes to the Mortgage Interest Deduction, if both ex-spouses continue to pay the mortgage, each one can deduct the percentage of interest that they actually pay. The same rule applies to the Property Tax Deduction so if both ex-spouses continue to pay the property tax, each one can deduct the percentage of property tax that they actually pay.
Guidance and Compliance Suggestions
Document the Payments: Have a detailed records of all payments made toward the mortgage and property taxes, it can eliminate confusion and disagreements.
Prove the Ownership: Have a detailed agreement that clearly states each person's responsibility for the mortgage payment and the property tax bill.
Communicate Clearly: A divorce agreement that documents each spouse’s agreed upon payment split in order to prevent future disputes.
Consult a Tax Advisor: Obtaining professional advise to make sure everything is IRS compliant and make the most of available deductions is encouraged.
With the help and guidance of a CDFA and other legal professionals, couples can better understand and avoid potential issues with the IRS and maximize tax deductions to achieve fair and equitable divorce settlements.
