How to Deal With Taxes When Getting a Divorce
Divorce is not an easy process for anyone to go through, no matter how straightforward it is. One of the many potential complications in dissolving a marriage is what to do with the home you own together.
One of the most common questions asked is what to do with the divorce and selling my home. Whether you choose to sell it and split the proceeds, for one of you to remain in the house and you both pay the mortgage – possibly to raise your children – or you buy out your spouse, you will still need to know what your tax situation will be. Whatever you decide, it is important to remember that there are tax obligations that you will be expected to deal with.
One of the most important financial considerations when getting divorced is the tax implications! Read on to see a number of tips for divorcing homeowners.
6 Tax Scenarios for Divorcing Couples That Own a Home
1. One spouse buys the other one out.
You or your spouse may want to keep the house free and clear of obligations to the spouse that is leaving. Say you want to keep the house and you want pay your spouse for his or her share of the home. You and your spouse can agree to a fair price. It does not have to be exactly half the value of the home if you do not want it to be. Many divorcing couples decide on a buyout price that is reflective of the others circumstances, such as each spouse’s income and who is taking care of the children.
You should consult with a Realtor to price the home and determine what number makes sense for a buyout. Most often the spouse that keeps the home will refinance it, but this is not always how people choose to do it. Again, it will be up to you and your spouse. In most cases you will not need to pay taxes related to the buyout. If you are the spouse that is leaving, you should get evidence in writing that the mortgage was paid for your records.
2. You both sell the house and split the proceeds.
This is one of the most common decisions following a divorce. You can find a Realtor with divorce experience you trust to list the home and then you and your spouse can split the profit from the sale in whatever way you see fit. When you sell a home that is your primary residence, you can walk away with up to $250,000 tax free if you are filing your taxes alone, and up to $500,000 if you and your spouse are filing jointly.
Keep in mind that you will need to prove that the home was your primary residence for at least two years of the last five to qualify for the tax-free status. You can also only use this benefit once every two years, so if you have sold a home recently it may not work for you. For a complete understand of how the real estate capital gains tax laws work, I would highly suggest reading this comprehensive article that explains in detail all of the tax ramifications when selling a home.
In regards to selling the home both parties should have a clear understanding of what the home is worth. Understanding proper pricing is one of the most important keys to selling real estate. One issue that I talk about in the article above is picking a real estate agent who not only has experience with divorce but is highly regarded when it comes to pricing homes correctly. Careful research should be done when hiring a Realtor in divorce. Given the fact there will be some sort of split of the divorce proceeds it makes sense to choose an agent who will be spot on with the value.
Pricing a home is a skill and an art that many real estate agents do not possess. Look for an agent who consistently comes close in the ratio between the initial list price and final sale price of the home. Careful considerations should be made in pricing the home based on both spouses’ goals. Do you both want out immediately? If so a more aggressive approach might be taken. This is something that should be discussed prior to ever meeting with any real estate agents. Make sure you are on the same page with your ex!
3. One spouse stays in the home to raise the kids, then you sell the home.
Some divorcing couples choose to retain the home until the kids are grown. There is a tax problem that can come from this decision, however, that you should be aware of – especially if you are the one that is moving out of the house.
As mentioned above, you can usually sell your primary residence and keep up to $250,000 in profit if you are filing singly. But to qualify you have to have lived in the home for two of the last five years, a qualification you may not meet if you are the one to leave the home. Fortunately, there is a solution to this problem, you just have to be aware of it and take the proper steps.
When you get divorced, you will need to have your attorney state in the divorce agreement that your spouse will have use of the home while you live elsewhere. In the agreement, you will need to state that the house is still considered your main home for tax purposes. You will need to have this documentation for the IRS when you finally do sell the home if you want to avoid a large tax bill.
The spouse that does remain in the home continues to receive other major tax benefits of owning a home. Understanding these tax perks is important especially when it comes time to file your taxes in April. There are some substantial advantages that home owners get over renters. Often times these benefits are forgotten about. This of course is like throwing money out the window! It is always important to brush up on current tax laws as they can potentially put thousands of dollars in your pocket.
4. You and your spouse share the home.
If you and your spouse agree to share the house for stability for your children, for instance, your tax obligations will depend on whether the house remains your primary residence. As mentioned above, there are tax advantages to this situation when you sell. If you can continue to have your mail sent to the home you can probably still list it as your residence for tax purposes, even if you spend some time at another property due to the sharing schedule you have with your ex-spouse.
This of course would only be for the brave of heart. Do you really want to be under the same roof with someone who you have decided you no longer want to be with? While this may seem like a smart financial idea it could be very stressful to your emotional health. This is something that should be given strong consideration.
5. You and your spouse own rental properties.
Because rental properties are not your primary residence, the tax issues they bring up will be different than with your primary home. Although you can transfer the properties to one spouse or the other without tax repercussions upon divorce, there will probably be taxes owed when one spouse sells the properties.
If you are dealing with rental properties in your divorce, you should consult with an accountant to decide what the best course of action is. Here is a great reference from the IRS that speaks to the issue of taxes of community property which can apply in divorce.
6. You have a vacation home.
Another important tax tip when getting divorced is thinking about what to do with a vacation home if applicable. Vacation homes, because they are not primary residences, do not qualify for the same tax exemptions as a regular home.
When you sell the vacation home because of the divorce, there will probably be capital gains tax to pay. How much this tax is will depend on your income.
As with owning rental properties, when you are dealing with the division of extra property like vacation homes you would probably benefit from talking to an accountant and a divorce attorney who have experience dealing with these kinds of financial issues.
Prior to 2008 you were able to exclude profits of $250,000 if single and $500,000 if married from capital gains tax on the sale of a second home due to The Housing Assistance Act. This legislation was put in place mostly for investment properties but vacation homes could certainly be counted as such.
You might be able qualify for a partial exclusion, however, if you lived in the residence for two years or more and treated the property as an investment property the rest of the time. For example, if you owned the home for a total of five years, and if you rented it out for the first three years then moved in yourself for the remaining two years, you might be able to exclude 40 percent of your profit from capital gains tax because the property was used as your primary residence for 40 percent of the time. Again you should always consult with a tax specialist because everyone’s circumstances are different.
Other Tax Considerations
When getting a divorce you should have a complete understanding of how tax laws work not only when selling your home but in general as well. Your divorce settlement is going to take into consideration a whole slew of things. This is complicated even further if you have kids.
For example, if you are the spouse who is paying alimony this can be deducted from your taxes as long as it spelled out in writing in your divorce agreement. On the other side of the coin if you are being paid alimony these amounts must be claimed on your income taxes. The exact opposite is true of child support. Whoever is paying the child support does not get a deduction and the person receiving the money does not report this as income.
You are probably thinking to yourself that if you are the breadwinner paying alimony has more beneficial tax benefits than paying child support!
Additional Tax Tips for Divorcing Homeowners
The complete IRS guide to tax questions while selling a home and getting divorced via The Internal Revenue Service.
Use these additional articles referenced above to make smart tax decisions when going through a divorce. All tax and financial advice should be verified with a certified accountant or other financial specialist before making any decisions on how to treat marital assets. Taxes and divorce can be complicated when intertwined. This is not something you should take lightly. Those that do often regret it sometime down the road.