Sidestep capital gains taxes when selling a home after death or divorce

For sale sign with sky in background

The Internal Revenue Service has a heart.


Like when it doesn’t require grieving or divorcing homeowners to pay capital gains tax on a property even if they don’t meet the general requirements of an exemption through Section 121 of the Internal Revenue Code.

(Click here to review the basic rules on how to sell your home without paying any capital gains taxes.)

The first exception governs the sale of a home whose owner has died.

Adult children often inherit the home of a deceased parent and find it impractical to actually live in the home.

Fortunately for them, capital gains on the sale of the inherited home can still be excluded from taxation if the deceased owner would have passed the “ownership” and “use” tests of Section 121 and the seller is the decedent’s estate or heirs.

Let’s say, for example, that Jim’s father dies in 2011, leaving his home to Jim. The father owned and primarily lived in the home since 1971. In 2012, Jim sells the home for a $50,000 capital gain.

Jim can exclude the entire gain because, as of 2012, Jim’s father passed the ownership and use tests of Section 121.

He owned the home and lived in the home for two of the five years preceding his death and the home’s subsequent sale.

The second common hardship is divorce.

If a spouse receives a home from his or her ex as part of a divorce, the spouse who receives the home is treated as owning it for the same period as the ex.

This is important for those who lived in but did not own the family home during the marriage.

Alternatively, if one divorcing spouse owns a home while the other is allowed to live in it, the “owner” spouse is deemed to have used the home during the period when the “resident” spouse actually used it.

Consider this example: Andrew and Rosie are married and live in Andrew’s condo starting in 2006. They file for divorce in 2011.

Rosie is not on the title of the condo, but the court allows her to live there until the divorce is finalized.

The divorce is not finalized until 2017. In 2017, Rosie leaves and Andrew sells it the next day, realizing a capital gain of $150,000.

But Andrew can exclude the entire capital gain because he owned the condo since 2011 and is given credit for Rosie’s use of the condo.

Clint Costa is an attorney and CPA at the Chicago law firm of Shaheen, Novoselsky, Staat & Filipowski in Chicago.

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