Capital Gains Tax on the Sale of Your Home after Divorce
- What is a capital gains tax?
- How does it work if we sell and split?
- How does it work if one person buys out the other?
Going through the divorce divorce process is emotionally and financially hard. One of the biggest decisions you might have to make is what to do with the family home you shared with your former spouse.
Will you sell it? Will one spouse buy out the other? What about capital gains tax? Will that affect your divorce settlement?
What is a capital gains tax?
Capital gains tax is a levy you pay on the profit you make from selling assets like real estate or investments. If you bought your house for $200,000 and sold it for $300,000, you'd be liable for capital gains tax on the $100,000 profit.
Amid a divorce, the application of this tax can be complex. Whether you decide to sell the home together or if one spouse buys out the other, different tax implications come into play.
How does it work if we sell together and split the proceeds?
If you and your spouse decide to sell your marital home, you'll likely split the proceeds. The division typically depends on the terms of your divorce decree or settlement agreement. However, the application of capital gains tax could complicate matters. It could potentially impact how much each party ultimately receives.
The good news is that the IRS allows individuals to exclude up to $250,000 of capital gains on the sale of their principal residence. This exclusion doubles to $500,000 for divorcing couples filing jointly. So, if you sell your house while you're still legally married and meet certain residency requirements, you could potentially exclude a significant portion of your profit from capital gains tax.
The situation becomes more complex if you sell the house after your divorce has been finalized. In this case, each ex-spouse can only exclude up to $250,000 in capital gains. If the profit from the sale price of your home exceeds this amount, you could be hit with a hefty tax bill.
If one spouse has been living outside the home for a significant period before the sale, they may not meet the residency requirements to claim the exclusion. The IRS requires that you have lived in the home for at least two years out of the five-year period prior to the sale to qualify.
How does it work if one spouse buys out the other?
If instead one spouse decides to buy out the other as part of the divorce settlement, capital gains tax still applies, but in a different way. The selling spouse may be liable for capital gains tax on their portion of the home's increased value unless the buyout occurred during the divorce proceedings.
If you’re the buying spouse, you’ll owe capital gains on the increase in value when you sell the home. Notably, you’ll be able to claim an exclusion of $250,000, provided you meet the IRS qualifications when you sell.
Check out our home equity split calculator designed expressly for divorcing spouses to play with different possible financial scenarios. It’s free to use.
Strategies to minimize the amount paid
There are strategies to minimize the amount of capital gains tax you pay.
- One strategy is to sell the home before your divorce is finalized. This allows you to take advantage of the $500,000 exclusion for married couples filing jointly rather than the individual $250,000 exclusion.
- Another strategy involves specific language in your divorce decree. For example, if the decree states that one spouse will live in the home for a certain number of years after the divorce, they may be able to claim the full $250,000 exclusion upon selling, even if the other spouse no longer lives there.
At Hello Divorce, we’re experts in our field. We get the ins and outs of what you’re going through – not only the emotional turmoil but also the legal and financial headaches you may face. We’re here to help. Want to learn more? Visit our plans page, our services menu, or our calendar to schedule a free 15-minute phone call with one of our friendly account coordinators.