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Question:

This is a divorce question regarding how capitol gain taxes apply if one spouse would like to “buy” the other spouse out. What is their tax basis after the divorce and is this generally a bad idea from a tax viewpoint. Or is it better not to buy out the house and just sell it outright and buy another to avoid having a big capital gains tax bill down the road when that spouse sells as a “single” person.

Response:

There are no capital gains issues if the property is transferred as part of the divorce proceedings and the basis in the property will not be affected. This is because an allocation of property in the context of a divorce is not a “buy out.” One spouse is not purchasing the other’s interest in the house. Instead, they are simply distributing their assets between themselves. Then the spouse who receives the house should make their decision about whether or not to keep the house as they would if they had always been single.

So, for instance, if a husband and wife purchased a house for $250,000 and it’s worth $500,000 when they divorce and it goes to the wife, her basis in the property will still be $250,000. If she subsequently sells it for $750,000, she will have $500,000 of capital gain ($750,000 – $250,000 = $500,000). She could, instead, sell the house immediately after the divorce, in which case she could exclude the $250,000 of gain. If she then bought a new place for $500,000 and sold it later for $750,000, she could again take her $250,000 exclusion as the homeowner, since homeowners can take this exclusion repeatedly as long as by the time of the sale they have owned and lived in the house for two years.

The one instance where the decision to keep or sell the house may be affected by the divorce if it has more than $250,000 of gain already. In that case, the divorcing spouses might want to sell it prior to their divorce since then they can together exclude up to $500,000 of capital gain.

But all this said, the tax tail should not wag the dog. It’s most important that you live in a place you want to live in no matter the tax consequences. If the divorcing spouse never sells the house, she’ll never have to pay any tax on capital gain.

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