If you are single, the rule is the same relating to the use of a home as a primary residence for two out of the previous five years, but the exclusion is only $250,000. Whether you are single or married, each person must satisfy the test that they lived in the home for two out of the previous five years as a primary residence. Anything less than that, and the exclusion is either reduced or it disappears.
The key to your question is whether you and your spouse will continue to live in the home and keep it as your primary residence. If you both satisfy the ownership rule and the use rule, you should be entitled to exclude from federal income taxes up to $500,000 total if you are filing a joint return or up to $250,000 each if you file separately.
We wonder, however, if as your divorce progresses, whether both of you will continue to satisfy these requirements and continue to file jointly. Keep in mind that many divorcing couples may start their new lives feeling one way about each other, but as time moves on, feelings change and one spouse may decide to move out of the home. Once a spouse moves out of the home, the clock starts ticking on the two out of the previous five years residency requirement.
If you and your ex-spouse are proceeding to sell the home and that sale comes soon, time probably won’t be an issue. On the other hand, if the divorce drags on and one spouse moves out, the spouse who moves out at some point may no longer qualify for the full exclusion of the $250,000.
If that situation changes, and one spouse is unable to get the exclusion, that spouse may want more from the marital assets to cover the anticipated taxes that may come down the line.
IRS Publication 523 does a good job of explaining in detail the requirements that homeowners need to satisfy to obtain the benefit of the $250,000 home-sale exclusion for a single person or $500,000 home-sale exclusion for married couples who file jointly. You can download Publication 523 from the IRS website or view it online.
One other thing you need to keep in mind: If you plan to take the exclusion, you can't have taken it for another home you sold in the past 24 months. And if you remarry before selling the prior home, you may fail to qualify for the exclusion.
If you and your former spouse appear to have at least $500,000 in profits from the sale of your current residence, you may want to talk to an accountant or tax professional to get further advice on what steps you should take to preserve the full amount exclusion. If you do something that precludes you from obtaining the exclusion and have to pay tax on the $500,000 in gains, that tax could be in excess of $100,000.
That could be your downside; but if you take care to preserve your exemptions, you and your ex-spouse should be entitled to each take up to $250,000 in exemptions. Please talk to a qualified tax professional or real estate attorney before taking any definitive actions as you go through your divorce.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (Fourth Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, ThinkGlink.com.