Question: Three ago, my wife and I built our dream house on a lake and put most of our assets – other than our retirements – into this property. Now, after 27 years, we have decided to separate and divorce and have also decided that it is best for us to sell our home as neither of us can afford to buy out the other. Because of its location, the house is now valued at $800,000, more than double our initial $300,000 investment. By selling the house, we will each receive $400,000 if we can avoid taxes. We are still living together, but want to separate. Because of the price of the property, we think it might take a while to sell it. We are trying to accomplish our settlement without lawyers and would appreciate your guidance as we do not want to pay capital gains taxes on our profit. Should we separate now or wait? Divorce now or wait? To complicate matters, I intend to remarry, and the woman I am going to marry will be selling her house after she divorces, but probably after she and I marry.

Answer: First and foremost, when dealing with assets of this size, not to mention retirement accounts, we believe that it is a big mistake not to seek competent legal and tax advice. This is especially true when, as here, you are trying to avoid capital gains taxes and the woman you intend to marry also wants to avoid the taxes. The information you receive from this column is designed to help you understand your options, not to give you legal or tax advice as each situation is different.

That said, The Taxpayer Relief Act of 1997 changed the way capital gains on the sale of primary residences are handled. Effective with sales taking place after May 6, 1997, a taxpayer can exclude $250,000 ($500,000 in the case of married taxpayers filing joint returns) of gain on the sale of a principal residence if certain conditions of ownership and use are met.

Unlike the prior law which was limited an exclusion to taxpayers age 55 and older and to only one exclusion in a lifetime, the current exclusion is available for all taxpayers regardless of age, and can be taken more than once. Unlike the former law where a spouse had to be using the residence as his or her principal residence at the time of the sale to qualify for the rollover; to be eligible for the exclusion today, a taxpayer must have both owned and used the residence as his or her principal residence for at least two of the preceding five years prior to the sale.

If you and your spouse file joint tax returns for the year of sale of your principal residence, only one of you is required to meet the ownership and use requirements. If one spouse receives the residence from the other based on the terms of a tax-free property transfer between spouses which is incident to divorce, the ownership holding period for the receiving spouse includes the period during which the transferring spouse owned the residence. For example, if the husband holds title to the principal residence during marriage, and transfers the residence to the wife pursuant to a divorce instrument, the wife will be deemed to have owned the residence for the period during which husband owned the residence.

However, when it comes to usage, the wife must meet these requirements independently. In the above example, if the wife did not live in the residence for two of the prior five years, she would not qualify for the exclusion until she does meet the use requirement. For that reason, if the residence is going to be sold immediately after a divorce, ownership of the residence should not be transferred to a spouse who does not independently meet the use requirement.

If an individual meets the ownership requirement, but his or her former spouse has use of the residence under a divorce or separation instrument, then that individual will be treated as having used the residence during the period that his or her spouse uses the residence. Another example: If husband and wife own the residence jointly and wife is granted use of the residence by a separation document, husband will be treated as meeting the use requirements if the residence is sold during the period wife has been granted the use of the residence. In other words, the husband would be treated as using the residence even though wife is the occupant in this scenario.

If a spouse uses the exclusion and then remarries, his or her new spouse is not bound by the two-year rule. In other words, the new spouse can sell his or her principal residence and qualify for the exclusion even though his or her new spouse used the exclusion within the previous two years; however, this exclusion will be limited to $250,000.

Bottom Line: Contact a lawyer and accountant to help you resolve these often confusing and difficult issues before you act.