Divorce CPA discusses Principal Residence Gain Exclusion Strategies | Section 121

As a divorce CPA, I hate seeing taxes add insult to injury. This post examines strategies for preserving the principal residence ($500,000 IRS gain exclusion) under various scenarios. The real estate market is in a slump, but homes can still sell for a gain. And the market could improve dramatically before the home sells.

“Somtimes the divorce decree needs specific verbiage to ensure keeping all the tax advantages when your marital residence sells.”
- Gary Bode, divorce CPA and tax accountant

Background

The principal residence gain exclusion, in IRC Section 121, allows up to $250,000 of gain exclusion for a single taxpayer ($500,000 for joint filers), on the sale of a home, provided it was owned and used as taxpayer’s principal residence for two of the last five years. Taxpayers can use this exclusion once every two years.

The Main Issue

When an ex-spouse continues to own all or part of the former marital residence, but doesn’t live there, the Section 121 gain exclusion disappears three years after moving out of the house. So all gain would be taxable - ouch! Unless the divorce decree has specific verbiage.

Electing Out of the Gain Exclusion Option

The ability to elect out of Section 121, even after filing a tax return, negates the possibility of being trapped by larger gains on a post divorce residence. You can simply amend a past return.

Sale before Divorce

Assuming the couple lived in the home two of the last five years,and hasn’t invoked Section 121 gain exclusion for at least two years, the process is simple.

• File jointly and exclude up to $500,000 of gain.
• File married filing separately and exclude up to $250,000 of gain each.

Scenarios that Warrant this Technique

• Both spouses continue to own the marital property after divorce. But only one lives there.
• The non-resident spouse still owns the home post divorce.

So how does the Non-Residence Ex-Spouse Protect Their Share of Gain Exclusion?

Divorce CPAs don’t draw up divorce decrees, of course, but here’s the essence of the specific verbiage required. Remember this assumes the other ex-spouse continues to live in the marital home. As a condition of the divorce agreement, the non-resident ex-spouse:

• Is allowed to continue to occupy the home for as long as he or she wants. We’re talking about taxes here. Talk to your lawyer about the realities of this clause. When I got divorced neither one of us wanted to live in the same house, so it was just words on paper.
• Or, is allowed to continue to occupy the home until the kids reach a certain age.
• Or, is allowed to continue to occupy the home for a specified number of years.

Now the full $500,000 exclusion still exists and when the home sells.

We’re a divorce CPA firm in Wilmington NC, with a virtual office to serve long distance and international client. Please read a few of our posts to judge our expertise and empathetic attitude. For a free phone consult, please call (910) 399-2705.