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Transfers of Assets in a Divorce Part II of III
January 20, 2010
Sale of Marital Residence
IRC §121 allows an exclusion up to $500,000 on the sale of a home that is owned and lived in as primary residence for 2 of the last 5 years. If the taxpayers do not meet the 2-year requirement, a prorated exclusion is allowed if the sale is due to a divorce (Temp Reg. 1.121-3T(e)).
The limitation on the excluded gain can be $500,000 if the joint return filers meet the following qualifications:
- Either spouse owns the property for at least 2 of the past 5 years
- Both spouses use the property as their primary residence for at least 2 of the past 5 years.
- Neither spouse has used the exclusion in the past 2 years.
The limitation on the excluded gain would be $250,000 for any party meeting all of the tests listed above and filing separately. The limitation would also be $250,000 if only one party was able to meet the above requirements, regardless of the filing status of the return.
Marital Residence - Tax Deductions
Mortgage interest and real estate taxes are deductible by the person paying the bill. If the payment was from a joint account, each party would be able to claim half of the tax deductible portions of the mortgage and real estate tax payments. If there is no proof of separate payment, it will likely be deemed a 50/50 split.
FILING STATUS
In the Year of Divorce
The IRS considers the marital status at December 31 to determine the tax filing status for an individual. As long as the divorce decree has been finalized by that date, the taxpayers are able to file as either single or head of household, depending on their qualifications. If the divorced taxpayer remarries before December 31 of that year, then the taxpayer would be obligated to file jointly or separately under the married categories.
Prior to the Final Divorce Decree
If the divorce has not been finalized, the taxpayers will generally have to file under one of the two allowable married categories:
- Filing Jointly (usually tax beneficial)
- Filing Separately (Ohio tax beneficial and legal liability protection)
Exceptions
There are a few exceptions to the required married filing status when the divorce is not yet finalized. If either of these two qualifications is met, the taxpayer can choose to file as single or head of household:
- There is a binding legal separation agreement in place by the court
- Abandoned Spouse - (for head of household purposes)
- Taxpayers lived apart for the last six months of the tax year
- The taxpayer provided principal place of abode for eligible child
- The taxpayer pays more than one half of the cost of maintaining his household for the year
The abandoned spouse issue is one that is commonly missed by taxpayers. Either they fail to tell their tax preparers, or tax preparers are unfamiliar with the abandoned spouse exception. Proper planning can achieve the ability for both spouses in a multi-child environment to be able to claim head-of-household, rather than the much more detrimental married-filing-separate status.
ESTIMATED TAX PAYMENTS AND REFUNDS
Allocations of previously paid estimated payments can be made any way that best benefits the taxpayers. In the year that the divorce is final, if payments were already made, a statement would need to be attached to both the returns showing the total payments and how they should be allocated.
If an agreement cannot be reached, the allocation is based on prior year tax recalculated as though separate returns were filed. An accountant would have to re-prepare prior year tax returns, assuming the taxpayers wanted to file separately, and determine the total tax on each return. The amount of each taxpayer's tax divided by the total tax liability would be their deemed percentage of the estimated payment made throughout the year. Ideally, this should be avoided. Breaking out a prior year joint return into separate returns will generate even more debates about who should get the various deductions, credits, children, and even the prior year estimated payments.
To avoid late payment and interest penalties for the current year, the prior year "safe harbor" is calculated the same as if an agreement had not been reached for current year estimates, and the prior year returns would have to be recalculated to determine each taxpayer's prior year liability percentage.
by: Richard L. Craig, CPA/ABV/CFF, CVA, CITP
