Dividing assets fairly is one of the key challenges couples face when navigating divorce, and it often starts with the largest single asset they may own — the house.
Since residential real estate has historically appreciated in value over time, parties in divorce should proceed carefully to avoid significant — and preventable — tax penalties. After all, a house is frequently the largest single asset a couple may own.
Beware of a surprise tax bill following divorce
Accounting for the value and potential capital gains tax when one party in divorce wants to keep the home requires special considerations. Lawyer and CPA Adam Mundt of McClure Law Group highlighted some of the key points on a recent episode of The Melinda Eitzen Show.
“If you’ve had the residence for a long time, there could be substantial appreciation in value, and you may have to pay income tax after the sale,” Mundt said.
For example, some individuals navigating a divorce feel overwhelmed and don’t want to think about what to do with the house while a divorce is active. One party or the other may be attracted to the stability of maintaining ownership even if the home is too large for their needs or not suitable for other reasons.
“I have people who say, ‘Oh, my goodness, I can’t go through divorce and move at the same time.’ Sometimes they don’t intend to keep the house long-term, but they just can’t mentally deal with it,” said Duffee + Eitzen co-founder Melinda Eitzen. “They say, ‘That’s fine, award the house to me and give her or him a bunch of other assets.’ But they do end up selling it sometimes within a year. So they should think more about that because they would be better off collectively selling the house while going through the divorce. Or they could co-own it post divorce and have a deal about what happens when it’s sold — but just not pay the government more money than they have to.”
All of these considerations should be part of the negotiation process, according to Eitzen.
Consider the following options based on a hypothetical case: A married couple purchases a home for $100,000 early in their marriage. The home appreciates in value to $1 million by the time they file for divorce years later. The $900,000 profit is considered a capital gain by the IRS that can be taxed up to 20 percent based on an individual’s income bracket.
Scenario One:
If the house is sold while it’s still jointly owned by the divorcing couple, the IRS allows each owner to “exclude” $250K of capital gains from taxation. By selling the home together, the taxable value is reduced by $500,000, leaving $400,000 of the profit subject to the capital gains tax. *if certain conditions are met
Scenario Two:
The husband or wife keeps the house after the divorce but later decides to sell. In this scenario, the sole owner can exclude only $250,000 of the capital gains, meaning $650,000 would be taxed. Depending on the income bracket, the IRS tax rate on capital gains is up to 20 percent, so paying taxes on the additional $250,000 in capital gains could result in an additional $75,000 tax bill. *if certain conditions are met
Gray Divorce Trends
Financial puzzles like these are common for divorcing couples of any age, but they’re a particular dilemma for Americans over age 50 who are part of what the American Association of Retired Persons calls the “gray divorce” trend. This is because adults divorcing after longer marriages tend to have significant financial assets to divide.
Although divorce has fallen slightly among young adults, it has accelerated among middle-aged and older adults. The divorce rate for this demographic has more than tripled since 1990. One in every three adults divorcing today is over age 50 compared to fewer than one in 10 in 1990, according to a study by Ball State University.
About Duffee + Eitzen
Our North Texas divorce law firm represents clients facing high-stakes divorce and custody matters and family law disputes with complex business and economic components.
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