One of the biggest questions that hangs over a divorce is what to do about the family home. The family home often has both emotional and financial value, and when you add the high cost of real estate in Massachusetts, divorcing spouses will want to get the best out of the sale.
Who Pays Capital Gains Tax in Divorce?
Capital gains tax is typically paid by the spouse who sells the property or receives proceeds from a sale. Spouses may sell the house as co-owners, or one spouse may buy out the other and become responsible for any taxes related to a future sale of the home. If the house is sold during the divorce or one spouse buys out the other, the selling spouse becomes responsible for CGT on any profit above their cost basis.
Property transfers “incident to divorce” (such as transferring the house title from one spouse to another as part of the settlement) are generally free of capital gains costs under IRS code §1041(a). The recipient spouse inherits the original cost basis and will pay CGT when they eventually sell.
When Is Capital Gains Tax Triggered?
Capital Gains Tax is triggered upon the actual sale of the property, not by property division itself during divorce. However, it’s important to remember that decisions made during the divorce process, including as part of the divorce settlement, may have a significant influence on tax consequences in the future.
If a couple sells the home before the divorce is finalized, they can file jointly and exclude up to $500,000 of gain from CGT, assuming ownership and use conditions are met (living in the home for 2 of the last 5 years). If the home is sold after divorce, each spouse can exclude up to $250,000 of gains if they meet the requirements of use and ownership.
Why Does Cost Basis Matter?
The cost basis of the marital home in divorce is the original purchase price of the home plus any significant home improvements, minus any deductions such as insurance payouts. If one spouse wants to keep the marital home in a divorce, and the home is transferred to that spouse as part of the divorce settlement, the spouse will receive the cost basis of the home and will pay capital gains tax on the appreciated value of the property when they eventually sell it. It is important for your attorney to know if there were significant renovations done to your home prior to the divorce, because oftentimes one party kept track of those expenses, and we can make it a requirement that all receipts or other documents related to work done to the home be provided to the party who retains the home.
Some spouses choose to sell the house before the divorce is finalized to avoid capital gains tax consequences in the future and to take advantage of the joint $500,000 exclusion.
Does the $250k/$500k Primary Residence Exclusion Still Apply After Divorce?
If the home is sold after the divorce, each ex-spouse can exclude up to $250,000 of gains individually if they meet residency requirements.
When filing as single individuals, each ex-spouse can claim their own $250,000 exclusion if they meet both the ownership and use tests individually. This means each must have owned the home and used it as their primary residence for at least 2 of the previous 5 years before the sale.
If the home is sold after the divorce, the $500,000 joint exclusion no longer applies; instead, each ex-spouse qualifies individually for the $250,000 exclusion.
Under Massachusetts law, if one spouse keeps the home, the residency of the non-resident ex-spouse can count toward the 2-year residency requirement if stipulated in the divorce decree. Similarly, if the non-resident ex-spouse still meets ownership and use criteria, and the divorce decree allows counting the other spouse’s period of residence as their own for the “use” test, this can help the non-resident ex-spouse qualify for the exclusion even if they no longer live in the home.
Exceptions to Watch Out For
If the house has a non-residence tax status for any reason, this affects the capital gains tax exclusion. A common way this happens is when depreciation deductions are claimed for home office use. These deductions reduce the capital gains tax exclusion and could trigger unexpected tax consequences if spouses are not aware of this rule.
This also happens frequently when spouse’s own multiple properties, which do not qualify as primary residences, or where property is gifted to one of the parties from a parent during the marriage.
Seek the Support of an Experienced Massachusetts Divorce Attorney
The question of what to do about the family home in a Massachusetts divorce is a decision that should not be taken lightly. There is emotional weight to the decision, and there are also many financial consequences to consider. The decision is especially weighty in Massachusetts, where spouses going solo face high property prices and high interest rates.
At Mansur Law Group, we support people getting a divorce in Massachusetts to move forward with confidence in their divorce. Contact Mansur Law Group here, or call (978) 961-6389 today to schedule a confidential consultation about your divorce and discuss your options surrounding the marital home and any other property in the marital estate