Dan Reiter, CFP®, CPA
The marital home is often one of the most valuable assets that couples must divide during a divorce. Each spouse’s financial and tax situation requires consideration when determining who receives this key asset.
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Before fighting to keep the marital home, evaluate its long-term affordability. Consider the ongoing costs of maintaining the property, including mortgage payments, property taxes, insurance, utilities, and repairs. Your financial situation will likely change due to the divorce, so it’s important to determine whether you can realistically afford to maintain the home. If you’re unsure, it may be wise to reconsider keeping it, as doing so could lead to significant financial strain.
You divorce financial planner can help you make such a determination. Before you decide whether to negotiate for the marital home, understand how such a decision fits in with your financial situation post-divorce. Begin by getting clear on the answers to the following questions:
Choosing whether to continue to own the marital home is fraught with a lot of emotions. Objectively consider your situation by understanding how your answers to the questions above fit into the “big picture” of your long-term financial situation.
Tax implications are another important factor to consider when deciding what to do with the marital home. It’s easy for tax mistakes to occur during the divorce transition, which can result in sizeable dollar losses.
First, ensure you have adequate records to document the “cost basis” of your home. Cost basis is a tax term but is generally defined as the purchase price of the home plus the cost of any capital improvements. A capital improvement is something that adds value to your home, increases its life, or adapts it to new uses. Examples may include architectural additions, remodels, exterior improvements, or energy efficiency upgrades. Common repairs, such as painting or fixing a leaky faucet, are not capital improvements and do not increase your cost basis.
Generally, you'll owe capital gains tax on the difference between the sale price (less selling fees) and your cost basis. If you do not have adequate records to support what you paid or what dollars you put into the marital home, you may not be able to claim those dollars to help reduce your gain on the property sale.
There is also a special exclusion from taxable gains available for principal residences. This exclusion allows you to exclude up to $250,000 (or $500,000 for married couples filing jointly) of taxable gain from the sale of your primary residence.
To qualify for the exclusion, you must have owned and lived in the home for at least two of the five years preceding the sale. There are also special rules for ex-spouses who have moved out of the marital home. If your ex-spouse is granted use of the property under a divorce or separation agreement, the spouse that moved out may qualify for the exclusion if the ex-spouse lived in the home long enough to gain it.
To illustrate, let’s consider an example:
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A Divorce Example – Bob and Sue Smith Bob and Sue Smith just finished their separation agreement and divorce in August of 2024. Sue plans to continue to reside in the family home for a few more years until their youngest, Brian, heads off to college. Their home is worth $1 million, substantially more than the $400,000 they paid twenty-five years ago. There is no mortgage debt on the property. Their divorce agreement stipulates that they will each retain 50% joint ownership of the home and will split any proceeds according to their ownership percentages when the home is sold. However, Sue is given the right to live in the home until Brian is expected to go to college. Sue and Bob sell the home four years later for $1 million. Sue and Bob each realize a gain of $300,000 (one-half of the $1 million sale price less one-half of their respective cost of the property). However, both meet the requirements to exclude $250,000 of such gain from tax. Each report a taxable gain of $50,000 as part of their income. Assuming a tax rate of 20%, they would each individually pay $10,000 in tax—$20,000 in total. Let’s say that instead Sue negotiated to keep full ownership of the family home as part of the divorce agreement, and as a result, gave up $500,000 in other after-tax assets. She holds the home for four more years and then sells it for $1 million. Sue realizes a gain of $600,000. As an individual, she can only exclude up to $250,000 of the gain from tax. She has a taxable gain to her of $350,000. Assuming a tax rate of 20%, she owes tax of $70,000 on the sale. Bob’s exclusion cannot be used as he no longer owns the property, and they no longer file a joint return. The result? A tax cost that is $50,000 more than what would have occurred with a more carefully constructed plan! |
In this section we discussed how failing to consider long-term affordability of your marital home as part of your divorce can add considerable risk to your financial future. Moreover, ignoring tax implications on the future sale of the marital home as part of your divorce negotiations can result in significant dollar losses to taxes. To avoid such issues, meet with a financial professional well versed in both taxes and divorce planning. The cost of such planning may very well be a fraction of making costly errors.
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