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Selling your home the same year you get divorced?

Selling your home the same year you get divorced?

January 31, 2023

One of the biggest financial moves you're likely to make during the divorce process is splitting any real estate you own together. Regardless of whether you want to keep the home, if neither of you can afford to refinance (especially with current interest rates!) and buy the other out, you may find yourself needing to sell. If you've owned the home for a while and it has substantially appreciated, it's important that you understand the capital gain exemption.

If you sell a house for more than you paid for it (including capital improvements), the difference is referred to as a capital gain. Capital gains are taxable in the year they occur and the tax rate depends on your Income. If you owned the home for at least one year, you'll pay "long-term" capital gains tax, ranging from  0% - 20%. (If you owned the home for less than one year, you'll be subject to short-term capital gains tax, which is the same as ordinary tax rate, ranging from 10% - 37%)

You can imagine how hard it would be to come out ahead if you had to pay taxes on that entire capital gain on the sale of your home. Fortunately, there is an exemption that allows individuals to exclude up to $250,000 of capital gains from the sale of a primary residence, and couples to exclude up to $500,000 of capital gains. Keep in mind you must file as "Married Filing Jointly". Also keep in mind you need to have lived in the home for 2 of the last 5 years to be eligible for the exemption. You can find more information about this rule, and how to decide whether to keep or sell a home here.

The key for a divorcing couple is that if they are selling a home with over $250,000 in capital gains, they are ONLY eligible for the joint exemption of up to $500,000 if they file as married filing jointly. 

Let's look at this example: a couple buys a home together for $200,000, then years later, sell it for $700,000. (I'm leaving out capital improvements and realtor fees for easy math here)

$700,000 sale price

-$200,000 original purchase price

$500,000 capital gain

If, for the year in which the sale occurred, they file taxes as "Married Filing Jointly", the $500,000 is exempt from federal capital gains tax. So, $0 in capital gains tax is paid.

If they get a divorce during or after the year they become divorced, they will only be eligible for the individual exemption of $250,000. The remaining $250,000 of gain is taxable, likely triggering a $37,500 capital gains tax (if in the 15% bracket) on the sale of the home. 🤯 

If you find yourself in this scenario, please consult with your attorney and/or accountant about the pro's and con's of filing and selling in the same year v the pro's and con's of waiting to do either. Each choice has its own unique trade-offs and considerations. While I cannot give you legal or tax advice or tell you whether or not you should sell your home or get a divorce, I hope this post is helpful in understanding the pro's and con's of selling a home with significant capital gains.

*Note these figures are as of 2023, and are subject to change.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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