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The decision to stay in the marital home during the divorce process is not one to make lightly. Before changes to the tax law in 1997, divorcees could face a hefty capital gains tax following the sale of family home. Thankfully, tax law has changed. 

However, the capital gains tax exemption of up to $250,000 for a single person and $500,000 for a couple, does come with some caveats. In this blog we discuss these conditions and what divorcing couples need to know about the sale of marital home. 

Although Colorado taxes capital gains at 4.63%, our smoking hot real estate market may still mean you’ll owe capital gains tax if you don’t qualify for the exemption. 

For instance, let’s say you bought a home in the Denver metro area in 2011. Back in June 2011, the median home value dropped as low as $232,000. In November 2021, the month for which the most recent info is available, this amount jumped to $538,000. So in this case, the sale generated a profit of $306,000. In order to be exempt from paying capital gains on anything over $250,000, three conditions must be met. 

  1. You owned the home for a total of at least two years in the five-year period before the sale.
  2. You used the home as your primary residence for a total of at least two years in that same five-year period.
  3. You haven't excluded the gain from another home sale in the two-year period before the sale.

Note: A primary or principal home is a home where you've lived for at least two of the five years prior to the sale.

The first condition for a spouse to meet concerns what the IRS refer to as the “ownership period”

If one spouse, pursuant to a divorce decree or separation agreement is required to grant the other spouse the right to temporary possession of the home, but retains title to the home, and the home is later sold, the spouse that left will be treated as having owned the home for the period of time that the occupying spouse owned the home as principal residence. The one who left gets to assume the ownership period of the spouse who remains. 

The second condition is the “use period”

To qualify for the home sale capital gains tax exemption, you need to show you “used” or lived in the home as their principal residence for two out of the past five years.  The IRS actually looks at the two out of the past five years as 24 months out of the past 60 months. And they don’t need to be 24 continuous months, just 24 cumulative months.

Keep in mind that both soon to be ex spouses must be owners during sale of marital home to take the $250,000 exclusion.

The third condition is the “two year rule”

This means that if you sell after owning for less than two years, you’ll need to pay capital gains tax on any profit. The exemption only can apply after you’ve reached two years of ownership.

Our recommendation when one spouse moves out of the home is to get it in writing that you have an agreement for one spouse to remain in the home but that the spouse who left remains a co-owner. Make sure to include that this is pursuant to a divorce mediation or court order. 

Another important thing to note is to spell out how proceeds of the sale of marital home will be split. The tax liability does not necessarily go hand in hand with the way that the proceeds are split pursuant to the divorce decree.  So, for example, if John owns half the house and Mary owns half the house then each of them are responsible to pay taxes on their half of the house and if, under the property settlement, Mary was entitled to get all of the proceeds, or perhaps 75% of the proceeds, those are two separate things.

If one or both of you lived in a nursing home, the use requirement may be lessened to one year and if you claimed a home office exemption, this amount must be deducted from the $250,000 exemption. To fully understand all the conditions, exceptions and what you need to memorialize in writing, we suggest working with a financial professional. Each of our mediators at the Divorce Resource Centre of Colorado is a Certified Divorce Financial Analyst. We welcome your questions about the sale of the marital home in a complimentary 20 minute call with one of our experienced staff. 

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At Divorce Resource Centre of Colorado, we have a team of seasoned Certified Divorce Financial Analysts (CDFA) who provide a cost-effective, respectful mediation process that allows couples and families to rebuild a secure post-divorce future.
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