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New Tax Rules Make Marital Residence A More Valuable Asset



Before May 6, 1997, in order to avoid capital gains taxes on "principal residences," the selling spouse (or spouses) were required to roll over their gain into a new home (or homes) in order to avoid capital gains taxes. But if one spouse moved out of the home before the sale and the home was no longer considered to be his or her "principal residence," that spouse would not be able to qualify for the rollover and would be taxed on the gain.

For those 55 or older at the time of the sale, a one-time $125,000 exclusion from capital gains was available; however, because it was a "one-time" benefit, many difficulties arose, especially with second marriages where the new spouse also owned a home.

Since both of these complex provisions were repealed by the new law, the home has become a much more valuable asset because each spouse involved in the divorce will be able to exclude up to $250,000 of gain from the sale of the marital home from taxation.

To make matters even simpler, the home need not be a spouse's "principal residence" at the time of the sale -- just during two out of five years before the sale. And if one spouse moved out while the other continued to use the residence as his or her "principal residence" according to the terms of a divorce decree or separation agreement, the spouse who moved out will be able to "count" this time and still qualify.

And instead of the one-time "55 or over" exclusion during a lifetime, the new law allows a larger exclusion with no age requirement that can be used every two years, not just once in a lifetime.

In order to qualify for the exclusion, the following conditions must be met:

(1) the spouse taking the exclusion must have owned the home and used it as his or her principal residence for two out of five years before the sale, and

(2) the spouse who takes the exclusion can not have used the exclusion during the two years before the sale.

This means that if husband moves out of the family home and the divorce order allows wife will stay there for three years before the home is sold and the proceeds divided, husband will be treated just as though he had been living in the home during the three year period and will be able to use the exclusion.

But the period of time between the date the spouse moved out and the date on which the agreement or decree becomes effective does not count. In other words, should one spouse move out of the home for more than three years, in order to allow that spouse to qualify for the "two-of-five-years requirement," the agreement or court order must provide that the remaining spouse stays in the home for at least two more years.

What if the home is owned by one spouse and is sold prior to the divorce? So long as the couple files joint tax returns for the year of the sale, they can exclude up to $500,000 -- even though the home was owned by just one of them.

What if one spouse owned the home during the marriage and transferred the residence to the other as part of the divorce? The recipient spouse will be allowed to use the $250,000 exclusion even if the home is sold less than two years later because the former spouse's time of ownership "counts" for purposes of the two-out-of-five-years requirement.

What happens if one spouse uses the exclusion and then remarries? Under the new law, the new second spouse will still be eligible for the exclusion and can use it less than two years later. This is a change from the former "55 or over" exclusion which would not allow the new second spouse to be able to use the exclusion during the marriage.

What about vacation homes? The new rule that allows the spouse who moves to "count" the time the other spouse stays in the home applies not only to the marital home, but also to vacation homes or new homes so long as the decree or agreement provides for a spouse to live in a vacation home or new home that the spouses jointly own. In this event, both spouses can later exclude gain on the sale.

This is a basic outline of the new tax law and is not intended to be construed as either legal advice or tax advice. Because all situations are different, make sure to contact your tax advisor before making any decisions or taking any action.

© 1997, Flying Solo

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