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When do you need to think about capital gains tax in a divorce?

On Behalf of | May 26, 2023 | Asset Division

Texas is a community property state. That means that, in a divorce, couples divide their marital assets equally. When divorcing spouses have accumulated a lot of assets together over the course of a marriage, dividing them fairly gets complicated. For example, there can be serious tax consequences associated with the division of large assets like the family home or a vacation house.

If you are considering selling assets, it is important to think about the potential tax implications. Dividing or selling some of these assets could result in capital gains tax.

Transferring assets from one spouse to another

In general, under the U.S. Tax Code, section 1041, when one divorcing spouse transfers property to another as part of their divorce settlement or proceedings, the transfer is not subject to capital gains taxes. However, if a capital asset is sold and the divorcing spouses divide the proceeds from the sale, capital gains taxes may apply.

What is a capital asset?

According to the IRS, a capital asset is any asset owned for personal or investment use. Capital assets include residential homes, vacation houses or investment properties. When you sell a capital asset, the capital gain or loss is the difference between the price you paid for the asset and the money you made from its sale. A capital gain in the sale of a capital asset could trigger capital gains tax consequences.

Selling the family home

Married couples who have owned their marital home for at least five years are eligible for a $500,000 exclusion on capital gains taxes. However, they must have lived in the home for at least two of the five years. Single people are only eligible for a $250,000 exclusion on any capital gains taxes.

Accordingly, timing matters. If a divorcing couple is considering selling their home as part of their divorce settlement, they should consider selling it while they are still married. Selling the house before the divorce is finalized allows them to take advantage of the larger capital gains exclusion for married couples.

Selling a vacation home or an investment property

In a high-asset divorce, you are more likely to face capital gains taxes when you sell a vacation home or an investment property. However, if you or your spouse moves into the home and establishes residency for at least two years, you may be able to avoid capital gains taxes.

Living in the house for at least two years can convert the asset into a residential home. Sometimes, a divorcing couple decides to keep and share their vacation home. They agree to take turns using it. However, they will also have to agree on vacation schedules and who pays to maintain the property. If the divorce is not amicable and they are having trouble agreeing on the division of their assets, sharing the vacation property is probably not an option.

Be aware of possible capital gains tax consequences in your divorce

Transferring assets from one spouse to another as part of your divorce settlement will not trigger capital gains tax implications. However, divorcing spouses should be careful about agreeing to sell assets and property as part of their divorce settlement agreement. Selling property could easily trigger possible capital gains tax consequences.

An experienced divorce attorney who handles handles high-asset property division divorces will have other ideas and suggestions that may help you avoid unwanted tax consequences for selling your marital property.