Question: My wife and I have been involved in our case for six months, not because of our bickering, but because my lawyer and accountant tells me that the tax issues are very complicated and that I need a plan before I divorce. I own a home where my wife and the children have lived since I left two years ago to move in with my girlfriend. I have been making the house payments and paying the taxes and insurance. Although my wife and I have agreed to sell the house three years after we divorce so that the children will not be disrupted and to divide net proceeds 50%-50%, my lawyer tells me that I will have to pay capital gains taxes on my share of the proceeds - even if I purchase a new residence within two years.
It's not that I'm a dummy who can't understand, but from everything I have read, when I sell my personal residence, I am entitled to invest my equity in another house within two years and pay no capital gains taxes. No one can explain to my why this is not the case. I don't want to run up big bills learning the divorce tax business, but I sure would like to understand the basics of this frustrating process.
Answer: First of all, you are fortunate to have an attorney who recognizes that these important issues exist because, if ignored and not dealt with properly at divorce, you - and possibly your wife -- could get unexpected visits from the IRS and state taxing authorities years down the road when you least expect it.
When you moved out of your house more than two years ago, you obviously had no intention of returning. For this reason, the house will no longer be considered your "principal residence." This means that you will not be entitled to rollover your portion of the proceeds tax-free and that you will be taxed immediately on the total gain since you own the house. If you had owned a half-interest, you would have been taxed on only half of the gain.
Your lawyer is right: Before the divorce is final, you need a plan. For example, maybe you and your wife can agree to divide the equity after the capital gains taxes you will be required to pay are taken off the top. In this way, both of you will share in the tax burden. To do this, you will have to define "net proceeds" in this fashion.
Since we receive questions like yours quite often, and since most folks never know they have a tax problem until well after the fact, we have been looking for a marital tax resource that is comprehensive, yet easy for the public to understand. Well, we finally found it.
"Divorce and Taxes: Practical Tax Planning For The Divorce Lawyer and Client" is an 84-page publication written by Frances Tanner of Atlanta, Georgia which covers the tax aspects of everything from Alimony to Property Settlements to Personal Residence Issues to Family Businesses to IRA's and Retirement Plans to Estate Planning to Use of Trusts to Potential Problems with the IRS to such important miscellaneous issues as negotiating for the dependency exemption, premarital agreements, and the deductibility of legal fees. Available for $17.95 including shipping and handling, "Divorce and Taxes" is a terrific resource for the layman and an easily-accessible check list for divorce lawyers. To order, send check for $17.95 payable to "Divorce Tax" to us at P.O.Box 11704, Columbia, South Carolina 29211.
Jan Collins Stucker is an award-winning writer and editor. Jan Warner is a matrimonial, elder, and tax attorney. Both are based in Columbia, South Carolina. Flying Solo is seen in newspapers throughout the United States.
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