In some divorces, the marital home is sold and the proceeds are split somehow. In other divorces, one spouse is awarded the marital home or the spouses continue to own the home jointly, either of which defers its sale until sometime down the road. When the home is sold, the question arises as to whether capital gains tax will have to be paid.
If so, this can be up to 20% of the gain in federal tax and up to 13% in California state tax. Fortunately, capital gains tax does not have to be paid on most home sales.
Before we get to the rules allowing “exclusion” of the gain from your taxes, let’s first summarize how to figure out the amount of gain on a house sale.
Calculating Capital Gain
The basic formula is: capital gain (or loss) = selling price – selling expenses – purchase price – improvements.
Selling expenses do not include paying off the mortgage. The outstanding mortgage balance doesn’t figure at all in the amount of the capital gain.
Improvements are expenditures that added to the value of your home, prolonged its useful life, or adapted it to new uses. A new roof or a kitchen upgrade are considered improvements; repairs and paint jobs are not.
As an example, if you sold the marital home for $600,000, paid $45,000 in selling costs, bought the house for $230,000 and paid $25,000 to upgrade two bathrooms, your capital gain would be $600,000 – $45,000 – $230,000 – $25,000 = $300,000.
If you took a tax deduction in prior years for using part of the house as a home office, this will increase your gain.
As mentioned above, usually there is no capital gains tax to pay on the sale of a principal residence. Why? Because the tax laws allow large amounts of gain to be “excluded” from consideration.
The maximum amount of capital gain on a home sale that an individual can exclude from taxation is $250,000. A married couple filing jointly can exclude up to $500,000.
So in the example above, a married couple could exclude the whole $300,000 in capital gain and pay no tax. But an individual would owe capital gains tax on a gain of $50,000 ($300,000 – $250,000).
Capital Gains Tax Amounts
Capital gains are taxed by the federal government and by states.
For the IRS, in 2022, the long term capital gains tax rate (for assets held a year or more) could be 0%, 15% or 20%, depending on your filing status, and taxable income. For married couples filing jointly, the tax rate in 2022 is 0% if your total taxable income is $83,350 or less, 15% if your taxable income is between $83,350 and $517,200, and 20% if your taxable income is greater than $517,200. For individuals using the Single filing status, the tax rate in 2022 is 0% if your total taxable income is $41,675 or less, 15% if your taxable income is between $41, 675 and $459,750, and 20% if your taxable income is greater than $459,750.
California taxes long term capital gains in the same way that it taxes ordinary income. So depending on your tax bracket, the tax rate on the capital gain from a home sale will be anywhere between 0% and 13%.
Is Your Home Sale Eligible for the Exclusion of Capital Gains Tax?
Here are the basic eligibility requirements:
- The sale must be of your main home, i.e. your principal residence.
- You must have owned the home for at least 24 months (2 years) out of the last 5 years leading up to the date the sale closed.
- You must have used the home as your principal residence for at least 24 months of the previous 5 years. The 24 months of residence can fall anywhere within the 5-year period; it doesn’t have to be a single block of time.
- You may claim the exclusion only once during a two-year period. So the date of sale must be at least two years since you last sold a home and claimed the exclusion.
Here are some divorce-related rules and exceptions:
- Generally, if you transferred your home (or share of a jointly owned home) to a spouse as part of a divorce settlement, you are considered to have no gain or loss.
- If your home was transferred to you by a spouse, you can count any time when your spouse owned the home as time that you owned it. However, you must meet the residence requirement above on your own.
- Let’s say a separation or divorce occurred during the ownership of the home. If you were separated or divorced prior to the sale of the home, you can treat the home as your residence for tax purposes if:
- You are a sole or joint owner and
- Your spouse or former spouse is allowed to live in the home under a divorce or separation agreement and uses the home as his or her main home.
- If you don’t meet the eligibility requirements above, you may still qualify for a partial exclusion of gain. You can meet the requirements for a partial exclusion if the main reason for your home sale was a change in workplace location, a health issue, or an unforeseeable event. Becoming divorced or legally separated qualifies as an unforeseeable event.
The information above is summarized from IRS Publication 523 – Selling Your Home. For questions relating to your particular situation, you may want to consult with a tax professional and/or a Certified Divorce Financial Analyst (CDFA.