Capital Gains and the Home Sale Exclusion When You Sell in a Divorce

Often, no. If you meet the IRS ownership and use tests, you can exclude up to $250,000 of gain when you sell your main home, or up to $500,000 on a joint return, and a divorce doesn't take that away. What a divorce changes is which of those limits you can use, because your filing status, who still lives in the house and the date the sale closes all decide it.

I'm Dennis Mark Interdonato with The Dennis Mark Group at Keller Williams Realty Ocean Living. I'm a Master CDRE® (Certified Divorce Real Estate Expert), and I run divorce home sales across Monmouth and Ocean County. The tax question comes up early in a divorce sale, usually right after "what's the house worth?" I'm not a tax professional, so here's what the IRS publications say, and the questions to bring to your CPA before anyone signs a listing agreement or a settlement. This is general information, not legal, tax or lending advice.

How does the home sale exclusion work?

IRS Publication 523 sets out an eligibility test. Three parts of it matter most here:

• Ownership. You owned the home for at least 24 months out of the 5 years before the closing.
• Residence. You lived in it for at least 24 months (730 days) during those same 5 years. The months don't have to be in a row.
• Look-back. You didn't exclude gain on another home sale during the 2 years before this one.

Meet all three and you can exclude up to $250,000 of gain. For a married couple filing jointly the limit is $500,000, with a catch: only one spouse has to meet the ownership test, but each spouse has to meet the residence test on their own to get the full amount.

What changes when you're divorcing?

Mostly, your filing status. IRS Publication 504 says you're unmarried for the whole year if you have a final decree of divorce or separate maintenance by the last day of the tax year. If you're separated but the divorce isn't final by then, you're treated as married for that year.

That's why the closing date and the divorce date have to be looked at together:

• If the sale closes in a year when you can still file a joint return, and both of you meet the residence test, the $500,000 limit may be on the table.
• If you file separately, or as single filers because the divorce is final, each of you measures your own share of the gain against a $250,000 limit.

Publication 504 also says that when you sell property you own jointly, you each report your share of any recognized gain, and your share is set by your state's law on property ownership. How your share is figured is a question for your attorney and your tax professional.

What if one of you already moved out?

Publication 523 says a separated or divorced owner can still treat the home as their residence if they're a sole or joint owner and their spouse or former spouse is allowed to live in the home under a divorce or separation instrument and uses it as their main home.

The IRS defines that instrument as a decree of divorce or separate maintenance (or a written instrument incident to one), a written separation agreement, or a decree that requires one spouse to make support payments to the other. Ask your attorney whether your paperwork says who is allowed to live in the home.

What if one of you takes the house now and sells it later?

A buyout and a later sale are two different tax events.

The transfer. Publication 523 says that if you transfer your home, or your share of it, to a spouse or ex-spouse as part of a divorce settlement, you're generally considered to have no gain or loss. The exception is a spouse or ex-spouse who is a nonresident alien. Publication 504 adds that the spouse who receives the home takes over the same adjusted basis.

The later sale. If your home was transferred to you by a spouse or ex-spouse, you can count the time your spouse owned it as time you owned it. You still have to meet the residence test yourself.

New Jersey has its own question about that transfer, the realty transfer fee. Here's when a deed between spouses is exempt from New Jersey's realty transfer fee.

Does New Jersey treat the gain differently?

For the exclusion, no. The NJ Division of Taxation's guide to buying or selling a home says you may be able to exclude all or part of the gain on a New Jersey home based on the federal guidelines, and that a capital gain is calculated the same way for New Jersey as for federal purposes.

What New Jersey adds is paperwork at closing. Every seller completes a GIT/REP form to record the deed. A resident who stays in New Jersey files the GIT/REP-3 and settles up on their regular return. The Division says a resident who sells and moves out of New Jersey is considered a nonresident for the sale, and New Jersey may require an estimated tax payment at closing. If either owner is leaving the state, tell your attorney early.

What records should you pull together now?

Your gain is the amount you realize from the sale minus your adjusted basis. Publication 523 says the cost of additions and improvements is added to basis, and your selling expenses count too. It also says to keep the records that document your adjusted basis until 3 years after the due date of your return for the year of the sale. Start with:

• The closing statement from when you bought the home
• Receipts, contracts and permits for improvements, such as a roof, an addition or a kitchen
• Any refinance or home equity paperwork
• The closing statement from this sale

I'm a former New Jersey home builder and residential remodeler, so I can walk the house with both of you and help list the work that was done over the years. Whether each item counts toward basis is your tax professional's call.

What are the most common mistakes?

• Assuming the $500,000 limit applies. It depends on a joint return and on both of you meeting the residence test.
• Moving out without the right paperwork. The separation rule depends on what your document says.
• Signing first and asking later. Have your tax professional run the numbers before the settlement or the listing agreement is signed.
• Losing the improvement records. Every receipt that adds to basis can lower the taxable gain.
• Forgetting the owner who moved out of state. A nonresident seller may face an estimated payment at closing.

My part in all of this is the number. Both owners, and your attorneys and CPA, get the same home value and the same net-proceeds estimate, so the tax math starts from one figure everyone can see.

Frequently Asked Questions

Can each of us exclude $250,000 if we don't file jointly?

Publication 523 lists $250,000 as the maximum exclusion for single and married-filing-separately filers who meet the residence, ownership and look-back requirements. Each of you applies it to your own share of the gain, and your tax professional runs the numbers.

Do I lose the exclusion if I moved out before the sale?

Not necessarily. If your spouse or former spouse is allowed to live in the home under a divorce or separation instrument and uses it as their main home, Publication 523 lets you treat the home as your residence.

Is a buyout between spouses taxable?

Generally, no gain or loss is recognized on a transfer to a spouse, or to a former spouse when it's incident to the divorce, and the spouse who receives the home takes over the same basis (IRS Publications 504 and 523).

Does New Jersey have its own home sale exclusion?

New Jersey follows the federal guidelines for the principal residence exclusion, according to the NJ Division of Taxation.

This is general information, not legal, tax or lending advice. Tax rules change and every situation is different, so confirm everything here with your tax professional and your attorney.

About the author

Dennis Mark Interdonato is a REALTOR® and Master CDRE® who leads The Dennis Mark Group at Keller Williams Realty Ocean Living in Point Pleasant, NJ, helping buyers and sellers throughout New Jersey make their next move, with Monmouth and Ocean County as home base. Read more about Dennis Mark.

Keep reading

• Read the divorce home sale guide
• What comes out of the proceeds at a divorce closing
• A home owned before the marriage: separate vs. marital property
• When you sell your home, do you pay tax?
• Have a question this didn't answer? Send it to Dennis Mark.