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My husband and I separated almost three years ago and are finally getting a divorce and selling the home we bought together in 2017. He has lived there continuously while we were separated, but I have not. I know there is a rule that you must live in your home as a primary residence for two of the last five years or you may have to pay capital gains - but is that a rule for the still married but separated couple or a rule that is imposed on each tax payer individually? Starting next month, I won't qualify for the 2 years in five rule. We bought the home for $800K in 2017 and it will likely fetch $1.1M now. Maybe to dodge the tax I need to stay married to him until after the divorce? The house is empty now (as it is ready to be actively shown) - perhaps I need to "move in" (e.g. a sleeping bag and a pillow). Not sure it matters, but there has been $150,000 in improvements to the house.

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  • United States of America Feb 5, 2023 at 2:14

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You bought the house for $800K, and added $150K in improvements, so your basis is $950K. You plan to sell for $1.1M, giving you approx. $150K gain. With selling expenses at about 10%, it's actually closer to $50K, giving each spouse $25K taxable gain at long term capital gain rates. Not sure if you want to spend legal fees on trying to mitigate that hit, but if you do here are some options:

  • Have your ex buy you out of the home and transfer you more cash or other after-tax value from your marital estate to be divided. Transfers between spouses are non-taxable and your ex can exclude all the gain from the sale of the house on their own, so it would be a wash.
  • Hold off the dissolution into the next tax year after the sale and report the sale on an MFJ tax return, that way you'll still get the tax break.

Your tax advisor and divorce attorney may come up with additional strategies that may not need cooperation from your ex like the above two. You're not the first to be in this situation.

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