Discussing potential capital gains tax in divorce settlements isn't something that most people think about when getting divorced. If you will be keeping the marital home, you need to consider how the eventual sale of the home will affect your taxes when drafting your divorce agreement. The following question on this issue shows what needs to be factored in when splitting the equity in the family home.
Maryann's Question: The house that we are selling is in my name, and the profit will be split 60/40 because I invested more into the house. How will this affect my taxes and what questions or protections should I consider? I don't want to end up paying taxes on money that will be going to him.
Timothy's Answer: You are wise to be questioning the potential capital gains tax before your divorce is final. It's best to first understand some of the IRS tax rules regarding the sale of the main family home. The IRS currently allows a married couple to exclude gains of up to $500,000 from their taxable income, while individuals can exclude up to $250,000. To qualify for this exclusion, the house has to be your main residence and you must have lived in and maintained ownership of the house for at least 2 years of the 5 year period preceding the sale of the home.
To figure the gain or loss on the sale of the home you will need to determine your basis. For most people, this is the original amount you paid for your home. However, you will need to calculate your adjusted basis if you made any additions or improvements or took any deductions while owning the home. For instance, if you originally paid $200,000 for the home and then put in a $14,000 pool, the adjusted basis then becomes $214,000. If later on, you had a $7,000 loss due to a flood; your adjusted basis would then become $207,000. For tax purposes, you need to subtract the adjusted basis and the expenses for selling the home from the final selling price of the house to calculate your profit or loss on the house. If the resulting number is positive, you have a realized a gain on the property. If the number is negative you have incurred a loss. The taxable gain is calculated by deducting the total allowable exclusions from the profit realized on the sale of the home.
If you determine that you will end up having a taxable gain, you should consider including a clause or stipulation in your divorce agreement which states something similar to the following: The parties agree that the property located at 125 Lynn Street, Westminster, CO 80031, shall be listed for sale at market price. Net proceeds from this sale, after deducting all expenses, mortgages, taxes, and liens shall be distributed proportionally as follows - 40% to the Husband and 60% to the Wife.
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