Divorce and Capitol gains tax

[tyandi]

What is the name of your state? NC
My wife and I purchased a home together in January 2004 (2 1/2 years owned) We are going through a divorce, and I separated (not legal) just physically for a year now. She has lived in the house the 2 1/2 years, but since I separated, I have just lived in it technically 1 year and 9 months. I since have paid the taxes, insurance. My question is if we split the assets 50/50, will I have to pay capitol gains tax on my portion since I did not live in the house two years? Or would it still be considered that I am in the house still?

Thanks in advance,

 

[tranquility]

If you had seperated legally, you would have no problem as you would be able to use the time in the house of your spouse as yours if it was under a divorce or separation agreements (Code sec 121(d)(3)). You will not be able to exclude $500,000 if you file jointly as both did not meet the use test as you have been gone a year. (Other reasons too.)

You can consider the divorce or *legal* seperation an "unforseen circumstance" and get a partial exclusion.

 

[LdiJ]

If you had seperated legally, you would have no problem as you would be able to use the time in the house of your spouse as yours if it was under a divorce or separation agreements (Code sec 121(d)(3)). You will not be able to exclude $500,000 if you file jointly as both did not meet the use test as you have been gone a year. (Other reasons too.)

You can consider the divorce or *legal* seperation an "unforseen circumstance" and get a partial exclusion.

I disagree Tranquility. The are not divorced and its still the marital home. The fact that she resides there means that he can piggy back onto her residency. I have seen case law on that issue. (It was a case law research problem in one of my master's classes) His position is just as strong as if there had been a legal separation.

However, you are also right that even if he wasn't entitled to the full exclusion, divorce/separation is one of those qualifying factors for a partial exclusion. Since he resided there 21 months out of 24, he would still be entitled to a 218,750 exclusion.

Since apparently they have only owned the home for less than 5 years, its not very likely that there would be enough "gain", that 218,750 wouldn't cover his half.

 

[tranquility]

I disagree Tranquility. The are not divorced and its still the marital home. The fact that she resides there means that he can piggy back onto her residency. I have seen case law on that issue. (It was a case law research problem in one of my master's classes) His position is just as strong as if there had been a legal separation.

I can't disagree with you as I did not search the case law. However, code sec. 121(b)(2) gives the amount of excludable gain as $500,000 for married individuals filing jointly if:
1. either spouse meets the ownership test;
2. both spouses meet the use test;
3. neither spouse is ineligible for exclusion by virtue of a sale or exchange of a residence within the prior two years.

Note #2.

I note that per reg. 1.121-4(a) a *deceased* spouse can qualify as having lived in and owned for the same period of the surviving spouse. (As long as the surviving spouse has not yet remarried.) I've already mentioned 121(d)(3). Finally, an absence of an entire year is not considered a short temporary absence where the use test remains satisfied if a person goes on vacation or whatnot.

So, based on the requirement to take the full exemption on a joint return, the specific mention of exclusion allowed in a divorce or legal seperation, and the specific allowance in the situation of a surviving spouse, I believed the IRS and Congress could have anticipated this situation and chose not to.

Still, I have not searched case law and have no doubt some judge could fit these facts into the law to come up with the result you mention. If I have a chance I'll look tonight.

 

[LdiJ]

I can't disagree with you as I did not search the case law. However, code sec. 121(b)(2) gives the amount of excludable gain as $500,000 for married individuals filing jointly if:
1. either spouse meets the ownership test;
2. both spouses meet the use test;
3. neither spouse is ineligible for exclusion by virtue of a sale or exchange of a residence within the prior two years.

Note #2.

I note that per reg. 1.121-4(a) a *deceased* spouse can qualify as having lived in and owned for the same period of the surviving spouse. (As long as the surviving spouse has not yet remarried.) I've already mentioned 121(d)(3). Finally, an absence of an entire year is not considered a short temporary absence where the use test remains satisfied if a person goes on vacation or whatnot.

So, based on the requirement to take the full exemption on a joint return, the specific mention of exclusion allowed in a divorce or legal seperation, and the specific allowance in the situation of a surviving spouse, I believed the IRS and Congress could have anticipated this situation and chose not to.

Still, I have not searched case law and have no doubt some judge could fit these facts into the law to come up with the result you mention. If I have a chance I'll look tonight.

Although I am certain of my position, its really not worth you spending a ton of your time on case law. (I remember how much time I spend researching the darned question for class) He qualifies for a reduced exclusion anyway, and the reduction isn't much under the circumstances.

 

[tranquility]

On Jan 6, 2003 the regulations were finalized regarding what a primary residence is. They are [Reg. Section 1.121-1(b)(2)]:

WHAT IS A PRINCIPAL RESIDENCE?

The final regulations continue to provide that the residence that the taxpayer uses a majority of the time during the year will ordinarily be considered the taxpayer's principal residence. However, this test is not dispositive. The new rules also include the following non-exclusive list of factors that are relevant in identifying a property as a taxpayer's principal residence:

(1) the taxpayer's place of employment;

(2) the principal place of abode of the taxpayer's family members;

(3) the address listed on the taxpayer's federal and state tax
returns, driver's license, automobile registration, and voter
registration card;

(4) the taxpayer's mailing address for bills and correspondence;

(5) the location of the taxpayer's banks; and

(6) the location of religious organizations and recreational clubs
with which the taxpayer is affiliated.

There is nothing to indicate that, by law, one may take the place where a spouse is living as your time in the "use" test. It seems like there is a facts and circumstance test.

When was your class, pre or post 2003?

 

[LdiJ]

On Jan 6, 2003 the regulations were finalized regarding what a primary residence is. They are [Reg. Section 1.121-1(b)(2)]:

WHAT IS A PRINCIPAL RESIDENCE?

The final regulations continue to provide that the residence that the taxpayer uses a majority of the time during the year will ordinarily be considered the taxpayer's principal residence. However, this test is not dispositive. The new rules also include the following non-exclusive list of factors that are relevant in identifying a property as a taxpayer's principal residence:

(1) the taxpayer's place of employment;

(2) the principal place of abode of the taxpayer's family members;

(3) the address listed on the taxpayer's federal and state tax
returns, driver's license, automobile registration, and voter
registration card;

(4) the taxpayer's mailing address for bills and correspondence;

(5) the location of the taxpayer's banks; and

(6) the location of religious organizations and recreational clubs
with which the taxpayer is affiliated.

There is nothing to indicate that, by law, one may take the place where a spouse is living as your time in the "use" test. It seems like there is a facts and circumstance test.

When was your class, pre or post 2003?

My class was spring, 2004. I have been working on this master's for awhile...one class at a time.

 

[tranquility]

I did a quick search and found things related to a person in a nursing home when the spouse was at the personal residence. (full exclusion allowed, regs now reflect this) But there was nothing regarding 121 after 2003 (use regs made permanent) that I saw related to our circumstances. The code and regs both seem fairly complete on what constitutes use and divorce and seperation are clearly contemplated. The OP's facts do not seem to fall under the code and regs regarding a legal seperation.

While a case can be made based on facts and circumstances, we don't have all the facts to help make a determination. The OP can make his own determination as to if they fit. Even though it was only a quick search, I'm pretty sure there is not a clear answer in the case law which overcomes the dictates of the statutes and regs.

 

[LdiJ]

I did a quick search and found things related to a person in a nursing home when the spouse was at the personal residence. (full exclusion allowed, regs now reflect this) But there was nothing regarding 121 after 2003 (use regs made permanent) that I saw related to our circumstances. The code and regs both seem fairly complete on what constitutes use and divorce and seperation are clearly contemplated. The OP's facts do not seem to fall under the code and regs regarding a legal seperation.

While a case can be made based on facts and circumstances, we don't have all the facts to help make a determination. The OP can make his own determination as to if they fit. Even though it was only a quick search, I'm pretty sure there is not a clear answer in the case law which overcomes the dictates of the statutes and regs.

I wish I still had the case study. I was on a previous computer of mine that crashed. It took some serious digging to come up with the right answer. We spent about 3 weeks on the case. Basically, the answer was that a married couple is an economic "unit" and the residence of one of them is the residence of the other. It had nothing to do with the rules surrounding separation and divorce, because no legal separation existed. One of the cases involved a married couple that had two homes....and for a good number of years one of them resided in one of the homes, and the other in the other.

However again, in this case the rules surrounding divorce give him enough of an exclusion anyway, that its a moot point for this OP.

 

[nextwife]

The 1099 Reporting form can be viewed here:
http://www.charlesjones.com/cgi-bin/forms.cgi?state=1&id=14

THe occupancy question goes as follows:

(YES OR NO) I owned and used the residence as my principal residence for two or more years during the FIVE year period ending on the date of the sale or exchange of the residence

 

[LdiJ]

The 1099 Reporting form can be viewed here:
http://www.charlesjones.com/cgi-bin/forms.cgi?state=1&id=14

THe occupancy question goes as follows:

(YES OR NO) I owned and used the residence as my principal residence for two or more years during the FIVE year period ending on the date of the sale or exchange of the residence

The debate on this issue involves the definition of primary residence as per the tax code and the IRS regs....and how case law has ruled. Tranquility and I have been debating the issues based on those factors.

Tax law is a funny sort of animal, because only "authority" can be used in court. For example, one would assume that the IRS forms and publications would be "authority", but they are not....and its a well known fact that they are sometimes incorrect. Therefore, one would not use an IRS publication or form instruction in tax court, unless it was on the basis of "please don't charge me the penalty because I didn't know that I couldn't rely on the IRS Pub.".....and that might only apply if they didn't use a professional preparer.

What you quoted is totally accurate in most circumstances. However its not accurate as applied to divorces and legal separations, (which Tranq and I agree upon) and based on my research (backed up by tax professors) its not accurate in an informal separation.

Tranq and I have basically been debating whether or not my tax professors were correct or not...LOL...since I got a A on the case study.

The bad thing about tax law is that its incredibly complex. The good thing about tax law is that its also often very cut and dried. Emotion doesn't enter into tax law....at least in front of the judges...I can't say catagorically say that emotion doesn't factor in with an IRS agent....but it doesn't with the judges.

We won't definitely solve this issue on this forum. I won't spend the time to re-research it without a paying client and I doubt that Tranq will spend the time to do it either....and even if either of us went to that trouble to re-research it, its basically moot for the OP.

Someone in this circumstance needs to get a tax professional involved. Why? Because the cost of win/lose is directly related to the validity of your arguments. Penalties are tied to "reasonableness". Someone could lose in tax court and be assessed no penalties at all....or someone could lose in tax court and be assessed severe penalites.

Or someone could be famous and get their butt kicked for example purposes only.

 

[tyandi]

Fianl verdict?

I guess I still would like to know kind of what "Nextwife" said below. Since I lived in the house 21 months (My wife kicked me out) still own the home, still pay taxes on it, my wife lives there for over three years, would I be subject to capital gains taxes on my half of the equity?
I mean YES, I (we) have owned the home 3 years, however is not really my principal residence. My driver license still has that address, I was paying bills on that residence for over two years, and the mortgage.



THe occupancy question goes as follows:

(YES OR NO) I owned and used the residence as my principal residence for two or more years during the FIVE year period ending on the date of the sale or exchange of the residence

 

[LdiJ]

I guess I still would like to know kind of what "Nextwife" said below. Since I lived in the house 21 months (My wife kicked me out) still own the home, still pay taxes on it, my wife lives there for over three years, would I be subject to capital gains taxes on my half of the equity?
I mean YES, I (we) have owned the home 3 years, however is not really my principal residence. My driver license still has that address, I was paying bills on that residence for over two years, and the mortgage.



THe occupancy question goes as follows:

(YES OR NO) I owned and used the residence as my principal residence for two or more years during the FIVE year period ending on the date of the sale or exchange of the residence

Ok...let me explain something else. The one thing that Tranq and I (as tax professionals) both agree upon is that you are eligible for the reduced (pro-rated) exclusion, based on the divorce/separation, and your 21 months of residency. Therefore, you can probably exclude your share of the gain.

Your basis in the house is the price that you paid, plus the costs of any improvements, plus selling costs. You subtract the basis from the selling price to get your gain. You divide the gain in half. Unless you think your 1/2 of the gain is going to be greater than $218,750 then you don't have anything to worry about....assuming that you sell the home withing the required time frame......or she buys you out within the required time frame.

You would need to close on the buyout or sale by the end of 2008. There are several scenarios that allow for a reduced exclusion, and yours simply happens to be one of them.