Tip of the Month:

The spouse who leaves the family home can still get a $250,000 exclusion from capital gains taxes.

Before the Tax Relief Act 1997 (TRA ’97), if one spouse left the house two years before the divorce was final, they lost their ability to roll forward their capital gain. In cases where there is significant capital gain in the family home, TRA ’97 allows both spouses to take a $250,000 exclusion even though one spouse is awarded the house.

The old tax law prior to Tax Relief Act 1997 (TRA ’97) said,

- We could rollover our gain into a house of equal or greater value without realizing capital gains
- We could take a one time $125,000 exclusion from capital gains after age 55
- Our capital gains were taxed at 28%

Our new exclusions allowed under TRA ’97 include,

- Single taxpayers can exclude $250,000 from capital gains
- Married filing jointly can exclude $500,000 from capital gains
- These exclusions are allowed for one sale every 2 years
- The selling spouse must have lived in the house at least 2 out of the last 5 years.
(Change in place of employment, health or unforeseen circumstances allow an exception)

The new tax rates are,

- 20% maximum for taxpayers in upper brackets
- 10% for taxpayers in the 15% bracket

Ownership test
• If one spouse, pursuant to a divorce decree or separation agreement is required to grant the other spouse the right to temporary possession of the home, but retains title to the home, and the home is later sold, the non-occupying spouse will be treated as having owned the home for the period of time that the occupying spouse owned the home as principal residence.

Use Test
• In the event one spouse transfers a residence to the other pursuant to a divorce decree, the “transferring spouse” shall be able to include the “receiving spouse’s” use period in computing their own use period.

Note: If one or the other remarries prior to sale of home jointly owned with the former spouse, the remarried spouse can use the new spouse’s time in the home to meet residency requirements to use the “married filing jointly” exclusion amount.

Let’s look at some examples.

1. John and Mary are getting divorced. Under the divorce decree, John is awarded the jointly owned family home for four years. At the end of four years, John sells the home and 50% of the proceeds are sent to Mary.

Scenario A: John sells the home for $400,000. Mary will receive $200,000 and be entitled to use her $250,000 exclusion even though she has not lived in the home for the previous four years.

Scenario B: John sells the home for $750,000. Mary will receive $375,000. If the basis in the property was $100,000, Mary’s portion of the basis is $50,000 leaving her with $325,000 gain. Even though she uses her $250,000 exclusion, she will be taxed on $75,000 of gain.

$750,000 Sales price	$750,000 Sales price
100,000   Basis	375,000 John’s half
$650,000 Capital gain	375,000 Mary’s half

$375,000	Mary’s half of Sales Price
50,000	Mary’s half of Basis
325,000	Mary’s half of Capital Gain
-250,000	Mary’s Exclusion
$ 75,000	Amount Mary will be taxed on

One good thing that the new tax law gave us is that this is not a one-time exclusion. We can use it over again every two years. So each time we buy a house and sell it after two years, we can use the exclusion.