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Overlooking capital gains tax can be a costly divorce mistake

On Behalf of | May 18, 2023 | Divorce

When married couples in New Jersey choose to divorce, their primary residence is often their most valuable asset. Selling the home and dividing the proceeds provides a straightforward and equitable solution, but taking this path could leave spouses with a significant capital gains tax bill. This is because the $500,000 capital gains tax exemption the Internal Revenue Service allows married couples to claim is reduced to $250,000 for single filers.

Capital gains tax exemptions

New Jersey has some of the highest property prices in the country, so claiming the maximum capital gains tax exemption when selling a residence is usually important for divorcing couples. This is especially true in high-asset divorces. The couple can claim the maximum exemption by selling their home and remaining married until the end of the year. They can then file a joint tax return and claim the $500,000 capital gains tax exemption, or they can file separately and each claim the $250,000 exemption for single filers. This means delaying the divorce, but that may be a prudent step to take if the home is sold for a lot more than its purchase price.

Section 1041

When a divorcing spouse receives a primary residence in a divorce settlement, they are not required to pay capital gains tax if the home has appreciated in value. That is because Section 1041 of the IRS code states that no gain or loss is recognized when property is transferred incident to a divorce. To be considered incident to a divorce, a property transfer must be related to the end of a marriage or occur no longer than one year after a marriage ends.

Careful planning

Divorcing couples are usually eager to move on and start new lives, but acting hastily can sometimes have serious financial consequences. In many cases, it may be wise to sell the primary residence and then divorce the following year. Doing this ensures that the couple can claim the maximum capital gains tax exemption.