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Can Spouse That Moved Claim Capital Gains Exclusions?
Jan L. Warner & Jan Collins

Question: My wife and I separated nearly three years ago when I moved out of our home. Finally, as a part of our property settlement, the house is to be sold and the equity divided equally. We bought the home -- titled jointly -- 15 years ago for $185,000, and it is now worth just over $400,000. I am told there may be capital gains taxes on my share because I, as a joint owner, did not live in the home for two of the past five years. I will not sign an agreement if I don’t know the bottom line results, but the lawyer tells me to sign and not worry. To me, this is a very serious question that should be answered first.

Answer: We agree that an agreement should not be signed until you know all of the economic ramifications. While it is difficult to imagine experienced matrimonial lawyers not attuned to these important issues, if they are fuzzy about the answer, they should seek assistance from a certified public accountant or research the answer. After all, that’s what you are paying them to do. That said, while specifics of your situation should be reviewed by a certified public accountant who can then give you an opinion based on all of the facts, here are the basics:

For sales after May 6, 1997, the general rule is that if you owned and used the property as your principal residence for at least two of the five years before the sale, you may exclude from your gross income up to $250,000 of capital gain at the time of sale. Married people who file joint tax returns and meet additional qualifying factors may exclude up to $500,000 of gain in the year of the sale.

Because it is not unusual for a home to be sold as part of a divorce settlement after one of the spouses has not lived there for months or years, the law does cover the special problems that concern you. For example, in order for you to either acquire or preserve the required two-year occupancy period that is necessary to qualify your ownership interest for the total capital gains exclusion, you will be allowed to count your wife’s continued occupancy just as if you had been residing in the home so long as your wife’s occupancy was authorized by your divorce or separation agreement.

In other words, unless you and your wife had a written agreement or court order authorizing her continued occupancy – at least on a temporary basis, you may be impacted adversely.

Here, however, since the total capital gain amounts to less than $250,000, a possible solution might be for you to transfer your interest in the residence to your wife as part of your divorce settlement, she might be able to take advantage of the exclusion, and she could provide you with an amount of money in cash equal to one-half of the equity as property division – all tax free.

Bottom Line: This important question should have been addressed much earlier by your advisors so that you and your wife could have understood your options in advance of a last minute crisis. When it comes to your money, you can’t afford for your advisors to be “fuzzy.”

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