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Divorce and taxes: Some surprises for homeowners

May 21, 2006|Ann Perry | Special to The Times

Taxes often figure into the decision to keep or sell a home in a divorce. The gain, or profit, from a home sale can create a tax-free windfall for sellers if Internal Revenue Service rules are met.

Under the rules, a single taxpayer can exclude up to $250,000 from capital gains taxes, and married couples filing jointly are entitled to exclude as much as $500,000. Any gains higher than those amounts are taxed as capital gains, at either 10% or 15% for federal taxes, and up to 9.3% for California taxes. To qualify for the exclusion, however, an individual typically must have owned and lived in the home as a principal residence for two of the five years before the sale.

Divorcing couples, however, can sidestep these rules.

Take, for example, a man who buys out his wife's interest in the home for $400,000. She will owe no capital gains tax as long as the buyout is called for in the divorce papers or occurs within one year of the divorce proceedings becoming final, according to Ginita Wall, a San Diego certified public accountant.

That's because the $400,000 would be considered a gift between spouses, which is tax-free, and not a sale. The spouse who keeps a highly appreciated property, remains single and later sells, however, could face a big tax bill on the gain over $250,000.

But what if a divorcing couple decide it's best for one of them to remain in the house and put off selling the property for, say, another six years to allow a child to finish school? Won't the other lose the tax break?

Not if they take advantage of a special exclusive-use rule, Wall said. It allows both parties in this example to receive the break -- even though one of them won't meet the two-out-of-five-year residency test -- if both continue owning the property jointly, one has exclusive use of it and their agreement is spelled out in the divorce documents.

"It can't be based on a handshake," Wall said.

There is no time restriction under the rule, but Wall said most couples set a time limit in the divorce papers.

The nonresident spouse can claim the tax break, even if he or she has since bought another home. However, he or she is limited to taking the $250,000 break once every two years.

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