Marriage and Divorce

Married couples filing jointly may exclude up to $500,000 in gain, provided:

• either spouse owned the residence
• both spouses meet the use test, and
• neither spouse has sold a residence within the last two years.

If each member of a married couple owns and occupies a separate residence and files jointly, each may exclude up to $250,000 in gain when they sell. Also, if it's a new marriage and one spouse sold a residence within two years before the marriage (thereby disqualifying him or herself from the exclusion), the other spouse may still exclude up to $250,000 in gain on a residence owned before the marriage.

A new marriage may also double the tax break in some circumstances. Suppose a single man sold his principal residence on October 1, and gained 500,000 in profits. Let's also say that he and his girlfriend had been living in the house for two years (but wasn't on the title), so they both satisfy the use test. If they get married by midnight December 31 of the same year, they can file a joint return for that year and exclude the entire $500,000.

Divorced taxpayers may tack on the ownership and use of their residence by their former spouse. For example, say that upon divorce, the wife is allowed to live in the husband's residence until she sells it. He has owned the residence for 18 months. Once the sale occurs, the couple will split the profits 50-50.

If the wife sells the home nine months later, she may tack on her ex-husband's ownership to meet the two-year ownership test. Also, the husband may tack on his ex-wife's continued use of the residence to meet the two-year use test. Each one is entitled to exclude $250,000 of profits from the sale. Widowed taxpayers may also tack on the ownership and use by their deceased spouse.

Home Offices: A Tax Drawback

The exclusion does not apply to depreciation allowable on residences after May 6, 1997. If you are in a high tax bracket and plan to live in your home a long time, taking depreciation deductions for a home office is quite valuable right now. But if not, you might want to reconsider using a portion of your home as an office, because all depreciation deductions you take will be taxed at 25% when you sell the house. Example: A married couple sells a home with an adjusted basis (purchase price plus capital improvements) of $100,000 for $600,000. Over the years, they had taken $50,000 in depreciation deductions for a home office.