How to keep your capital gains tax break in a divorce

New York homeowners receive a significant tax break on capital gains from selling their homes. A divorce puts this valuable tax break at risk. Married couples can qualify for a tax break on up to $500,000 of capital gains income; single taxpayers can only receive a tax credit for up to $250,000 in capital gains.

Understanding the conditions and qualifications for the tax break can provide insight into the best way to preserve the maximum capital gain tax break possible.

Qualifying for the tax exemption

A seller must qualify in two different ways based on IRS rules to receive the capital gains tax exemption. The qualifying conditions apply to each person who wants to use the tax break, so it would apply to each spouse owning the home while they remain married.

The use test requires the seller to have the home as their principal residence for two out of the last five years before the home’s sale. The ownership test requires the seller to have owned the couple’s home for at least two of the last five years before the sale. Again, both spouses must pass the use and ownership tests to receive their share of the tax exemption.

Keeping the tax break in a divorce

If a couple remains married during the year they sell the house, they can still exclude up to $500,000 in capital gains from their taxes. The couple can file jointly as long as they both pass the use and ownership tests, or each can file their return as married, filing separately and claim a $250,000 exclusion on each return.

One spouse buys out the other one

If one spouse buys out the other’s share of the home, the ex-spouse who retains full ownership can only qualify for a $250,000 exclusion. If the couple should remarry and both meet the use and ownership requirements, they can take the full $500,000 exclusion.

Co-owners with a non-resident

Both spouses may decide to keep and co-own the home. However, if only one resides in the home, it creates a challenging tax situation for the other homeowner who no longer lives there. They may no longer meet the use test requirement. However, with a carefully drafted high asset divorce agreement, the non-resident spouse can get credit for the other spouse’s continued residence in the home when it becomes time to sell. This action would allow the non-resident spouse to qualify for a $250,000 exclusion on their tax return.

Navigating taxes during divorce can become especially challenging, but with proper planning and expert insight, you can preserve the maximum value of your home’s tax break.