Don Read, Tax Law for Family Law Attorneys

Internal Revenue Code §121 provides that a taxpayer who has lived in his or her principal residence for 2 of the last 5 years and who has not sold another principal residence within the last 2 years may exclude $250,000 of the capital gain realized on the sale of the residence. Treasury Regulation §1.121-1 sets out the basic rules of what constitutes a principal residence, §1.121-2 sets out the dollar limitations on the exemption, §1.121-3 describes when a partial exclusion is available for persons occupying the residence for less than 2 years or selling another residence within 2 years, §1.121-4 lists special rules (such as the "out spouse" rule). A taxpayer may elect out of this treatment (for example, if another residence with more gain is to be sold within 2 years).

Here are some of the issues that can arise:

Out Spouse. If one spouse (the "out-spouse") has been out of the house for more than three years but still owns half of the house, can he still qualify for the exclusion? Under certain circumstances the "out-spouse" can continue to qualify. This means that when the house is sold several years after separation (say when the youngest child graduates from high school), each former spouse may retain his or her $250,000 exclusion. See IRC §121(d)(3)(B).

Residence Owned by Only One Spouse. Under some circumstances, even if the residence is owned by only one spouse, but the spouses are married and file a joint return, there can still be a full $500,000 exclusion. See IRC §121(b)(2)(A).

One Spouse Transferred an Interest to the Other Spouse Within Two Years of the Sale. If one spouse transfers an interest in the house to the other spouse, even though the other spouse has not owned an interest in the house for two years, the other spouse may still qualify for a full exclusion. See IRC §121(d)(3)(A).

Partial Exclusion. Even if the spouses fail to meet the two year ownership and use test, or have sold another house within two years, under the right circumstances they may qualify for a partial exclusion. See IRC §121(c) and Regs. §1.121-3(e)(2)(iii)(D).

Expenses of the House. Often when one spouse has moved out, the "in-spouse" will pay all of the expenses of the house. Can the person paying the mortgage interest and property taxes deduct the whole expense, even though the co-owning out-spouse might seem to have been liable to the third party for half? Will payment of house expenses by the "out-spouse" be treated (in whole or in part) as payments "on behalf of" the "in-spouse" so as to be either a non-deductible Dividing Property or a deductible/taxable alimony payment to the "in-spouse?"

Home | About Don Read | News | Contact
Spousal & Family Support | Dividing Property | Dependency Exemption/Head of Household
Joint Return Liability; Reporting Community Income | Dividing Employee Benefits
Principal Residence | Gift & Estate Tax Issues | Registered Domestic Partners

Donald H. Read - Attorney and Certified Tax Law Specialist     Cell Phone: (510) 409-4927     E-Fax: (413) 677-0609