By Jonathan Fields, Esq.
The transfer of property between spouses and ex-spouses pursuant to a divorce generally is not considered a taxable event per §1041 of the Internal Revenue Code. See here for more information. So, you and your spouse can generally divide a retirement or brokerage account without tax consequences. The marital home, however, is a different story.
Under IRC §121, if you have a capital gain from the sale of your principal residence, you may qualify to exclude up to $250,000 of that gain from your income or up to $500,000 of that gain if you file a joint return with your spouse. The following “ownership and use” rules apply:
- During the 5-year period ending on the date of the sale or exchange, the residence must have been owned by either spouse and used by both spouses as their principal residence for periods aggregating 2 years or more.
- An individual shall be treated as using property as such individual’s principal residence during any period of ownership while such individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument.
- The exclusion can only be applied to one residence every two years.
In cases of divorce, taxpayers can benefit from both the ownership and use periods of former spouses to satisfy the requirements. If a taxpayer receives a home as part of a divorce property settlement, the taxpayer’s ownership period will include the time the spouse or former spouse owned the home. In addition, a taxpayer is treated as having used the home as a principal residence during the time the taxpayer owned the residence and the taxpayer’s spouse or former spouse was permitted to use it—under a decree of divorce or separation—as a principal residence.
A caveat that recurs with frequency in our practice: the exclusion does not apply to the extent it is used as a non-residence – i.e. a home office. Therefore, if the house is sold at a $250,000 gain but the taxpayer has taken $100,000 in depreciation deductions for home office use, then only $150,000 is eligible for the exclusion ($250,000 in realized gain less $100,000 depreciation).