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Family Law Article 1-B


Planning for the Disposition of the Marital Home


Two special rules are contained in Section 121 (d) for separated or divorced individuals selling the marital home. First, if the seller had become the owner of the home as a result of a Section 1041 transaction (an inter-spousal transfer), the seller’s holding period, for purposes of determining whether the gain or loss would be long-or short-term, includes the period of time that the transferor spouse or former spouse had owned the property. Second, if one spouse is given the right to occupy the house pursuant to a “divorce or separation instrument,” defined under Code Section 71(b) as a decree of divorce or separate maintenance, a decree requiring a spouse to pay to support or maintain the other spouse, or a written separation agreement, then the period of time that the occupant spouse uses the property as his or her principal residence is imputed to the other spouse. It should be noted that if one spouse leaves the marital home before a divorce or separation instrument is entered or executed then the period of time that a spouse occupies the marital home prior to the entry or execution of the divorce or separation instrument is not imputed to the nonoccupant spouse. Accordingly, the timing when a spouse vacates the marital home may be important for purposes of the nonrecognition provisions of section 121, depending upon the amount of time the vacating spouse had already lived in the home and how long after the entry or execution of the divorce instrument the parties intend to sell the home.

Among the specific rules included in Section 121 are that does not apply to sales by expatriates living outside of the United States, that the surviving spouse of a deceased owner of a principal residence may in certain circumstances satisfy the ownership and use requirements of Section 121 based upon the deceased spouse’s period of ownership and use, and that there is an opt-out provision. A taxpayer selling a principal residence may elect out of Section 121 by filing an income tax return for the year of sale that includes the resulting tax consequences in the taxpayer’s gross income.

The following are examples of the rules applicable to the disposition of the marital home in ease of divorce or permanent separation:

Example 1: Ike and Mamie, who are married, purchased a home six years ago for $250,000. It is currently worth $500,000. Mamie has an employer funded retirement account valued at $250,000. In addition, Ike and Mamie jointly own stock worth $250,000 but which cost them $125,000. Ike has been living separate and apart from Mamie for the past 18 months. Mamie has filed for divorce, Ike’s counsel proposes that the parties divide the marital property, with Ike to get the house and Mamie to keep the retirement plan benefit and stock. Mamie’s attorney, knowing the rules, objects to the proposal. She reminds her client of the old adage, that it is not what she gets; it is what she gets to keep. Under Ike’s proposal, upon a sale of the house at its current value he would keep the full $500,000, by reason of the $250,000 original cost basis and the $250,000 exclusion from gain under Section 121 of the Code. In contrast, although Mamie receives assets worth $500,000 before tax, upon sale of the stock and liquidation of the retirement account she would probably wind up with less than $400,000 after tax. She would be taxed for the $125,000 of profit on the stock sale at capital gain rates, short- or long-term, depending upon when they were acquired and at ordinary income rates upon liquidation of the retirement account (depending upon age and circumstances Mamie might owe an additional tax for early withdrawal). Mamie’s counsel responds to the proposal of Ike’s attorney that if the parties are to equitably distribute the marital property they must give due consideration to the after-tax value of the assets of the parties.

Example 2: Ike and Mamie’s factual circumstances are the same as set forth in example I except now Ike is the sole owner of the home and it is valued at $750,000. They permanently separate hut Mamie withdraws her complaint for divorce. The attorneys advise both parties to consider the sale of the marital home while Ike and Mamie still qualify for the $500,000 gain exclusion. They note that if the spouses continue to own the home but Ike lives elsewhere for more than three years, or if Ike and Mamie start to file separate income tax returns, they will only be entitled to a $250,000 gain exclusion upon a sale of the home. Indeed, even if Mamie eventually buys Ike out of the house, her income tax basis in the house is not increased and the exclusion from gain upon an eventual sale of the house to third parties is limited to the amount allowable for a single taxpayer.

The foregoing examples and brief overview of the law are meant to illustrate that the tax consequences of the disposition of the marital home is one of the most important matters to consider when planning for the division of marital property. Knowledge of the law is essential if the interests of the parties are truly to be protected and equitably distributed.

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