My husband and I own a house, but we've been living outside the country and renting it out. Now we have moved back to the U.S., and we are splitting up. He will live in the house for the next two years so we can qualify for the capital gains tax exemption. If I don't live in the house, and we divorce before it gets sold, will I have to pay capital gains taxes on half the earnings? Or if I don't live in the house, and we don't divorce before the house is sold, will I have to pay capital gains taxes?
-- Name withheld
The capital gains tax exemption allows you to exclude from taxation up to $250,000 of the profit on the sale of your home ? $500,000 if you're married filing jointly ? provided you own the home and occupied it as your primary residence for at least two of the last five years.
The good news: It appears that you'd be able to qualify for the $250,000 exclusion of capital gain on the eventual sale of the house if you're divorced and not living there. (Your husband would get a $250,000 exclusion as well.) Basically, if a taxpayer moves out of a jointly owned home due to a written divorce or separation agreement that gives her spouse permission to remain in the home, the spouse who moved out will be treated as having residence during the time in which the other spouse remains in the home. "If he stayed in the house for two years, you would then qualify for up to the $250,000 gain exclusion on your tax return, as long as the divorce agreement is written properly," says Mark Joseph, a financial planner and CPA in Reston, Va.
If you remain married but you don't live in the house, you will qualify for only one $250,000 exclusion between the two of you, because only one of you met the test of living in the house for two years.
That said, the exclusion may be limited because the home was rented prior to your husband living there. "Once you start renting the house, that is what is called 'non-qualified use,' and any gain allocated to that time period is not qualified for the exclusion," says Burt Hutchinson, a financial planner and CPA in Wilmington, Del. "Non-qualified use is any period after 2008 that the property was not used by you as a principal residence." There are exceptions to this rule ? for instance, it may not count as nonqualified use if you or your husband was on official extended duty as a member of the military. (See IRS Publication 523 for more exceptions.) You may also see a smaller exclusion if you depreciated the home during the rental period.
No matter what you do, please consult a good divorce attorney and a tax accountant before you make any big decisions. The rules on this are complicated, and the wrong move could cost you.
?Kate Ashford
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