On August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997 into law. The scope of the legislation encompasses measures ranging from a child care tax credit for low and moderate-income families to new tobacco taxes. The Act includes changes to the way capital gains are treated. For investments, tax rates were reduced from 15%-28% to 8%-20%, depending on income. There were also major changes on the way capital gains on homes sales will be treated for sales effective after May 6, 1997.
Previously, there were no taxes on profits if sellers bought another home within two years that cost at least as much. Buyers simply rolled the gain into their new home. Singles or married couples age 55 and older could exempt up to $125,000 of profits.
The Act allows taxpayers to exclude up to $250,000 ($500,000 in the case of a married couple filing a joint return), of gain realized on the sale or exchange of a principal residence. Taxpayers who have owned and occupied a principal residence for at least two of the five years prior to any sale may take advantage of the exclusion.
Note that if you and your spouse file a joint return for the year of the sale, you can exclude the gain if either spouse meets the ownership tests. Also important to note is that you are considered to have used the property as your main home during any period when you owned it, and, your spouse or former spouse is allowed to use it under a decree of divorce or separation.
some further clarifications were made to the article, as outlined in publication 523, "Selling Your Home." I hope it is apparent that decisions on what to do with the house will now be a little easier with the elimination of rollover requirements and one time exclusions.
Following child custody, no issue seems to cause more emotional trauma to people getting divorced than what happens to "The House." However, many people make significant financial mistakes in dealing with the house that can prove expensive. Hopefully, after reading this article, you will be able to evaluate the various alternatives more comfortably.
At the time of the separation, one party may choose to leave the family house to reduce the ongoing hostility with the other spouse. The children tend to stay with whoever chooses to remain in the house. There is the general perception that the person who leaves reduces their chances of custody, as the other parent now has the opportunity to create a stable, familiar environment for the children. Some lawyers suggest that you don't leave... others suggest that leave only after you have a formal separation agreement which spells out parenting time and equitable distribution, including your plans for the house. An important point to note is that if you are filing under the "no fault" grounds in New Jersey, you must have lived in and maintained separate residences for at least 18 consecutive months.
Adding to the complexity of the custody issues, the house presents comfort and stability at a very difficult time. People faced with changing roles, may not want to make yet another change. The house, as well as the furnishings in the house, may also represent a happier and more hopeful time in the marriage. However, sooner or later in the divorce process, at least one of the partner (and maybe both) will move, and decisions have to be made about what happens to the house.
In the course of this article, we will explore two primary tax scenarios:
Tax Scenario 1: If the house you and your spouse jointly own a primary residence that has a sales price of under $500,000, or you have under $500,000 gain, you need not worry about capital gains as long as you have both owned and occupied this as your principal residence for at least two of the five years. You own no taxes on your gain - a real gift to the middle class.
Tax Scenario 2: If you do have gains over $500,000, you will have to pay tax on the gain over $500,000, if you decide to sell the house. The maximum tax you are responsible for is 20% in addition to state taxes. If you sell the house, you can no longer defer or rollover gain.
If you have a loss on the sale of your home, you unfortunately cannot use this loss to offset other gains or to reduce the basis of any new home. However, you must report this loss on your income taxes.
In deciding what happens to the house, which we are considering your main home that is owned jointly with your spouse, some of the common alternatives we will explore in this article include:
- Selling the house prior the divorce
- Selling the house shortly following the divorce
- Agreeing to sell the house at a future date and maintaining a joint interest in the house
- Transferring title to one of the parties as part of the judgment of divorce
One other option that I won't go into details on in this article is renting out the house you own. Please speak to your tax consultant before considering this alternative seriously. When you go to sell the house, you will be responsible for all capital gains, as the house is considered investment property rather than your primary residence. Additionally, you must now depreciate this property. This option may make sense if you anticipate a loss on the property, and/or are in a poor sales market but a strong rental market.