Divorce Loophole

[Zee]

"Loophole can save divorcing couples thousands of dollars". That's the title of a newspaper article I read today in the real estate section of our local paper in response to the following readers question; "I'm getting divorced and soon will move out of our longtime home. However, my wife and I will keep th co-ownershiping of the house so she can continue living three with my two young children until the children both graduate from high school, and perhaps even college, which could be more than 10 years from now. If we sell the property eight or 10 years from now, how would our profit be taxed?"

Here's the part of the answer containing the supposed "loophole"(suggesting a strategy to retain the exclusion for the husband); "By inserting just an extra paragraph or two into your divorce agreement that says your ex-spous can remain in the home for as long as she wants, or until the children reach legal age, or by setting up pretty much any other ownership and sale restriction on your ex's use of the property, the IRS will probably give you "credit" for her continued use and let you too keep up to $250,000 of the eventual sale tax free".

This doesn't sound right to me...maybe there's something I'm missing. What do you brighter minds think? If it's a valid tactic, it'd be nice to know.

[newbie]

Per Pub 523

You are considered to have used property as your main home during any period when: You owned it, AND Your spouse or former spouse is allowed to live in it under a divorce or separation instument and uses it as his or her main home.

........says your ex-spous can remain in the home for as long as she wants.......

So I would say the statement if ex-spouse can does not qualify unless the ex-spouse actually does, yes it will qualify.

[Zee]

Thanks for the quick response. It appears the "loophole" is correct. I didn't know that. It worries me that I didn't. I know I've read the sentence you listed before, but had long forgotten. I guess that points out the need for researching and reading the publications before making certain decisions. This would be a valuable planning tool for clients in the divorce process, I wouldn't have thought to advise them of this situation when consulting with their divorce attorney. I wonder if it's safe to assume most divorce attorney's would routinely add the language in such situations?

[jainen]

There is nothing routine

>>it's safe to assume most divorce attorney's would routinely add the language<<

There is nothing routine in a divorce. The ongoing ownership of the family home is often the most difficult part of negotiations. This "loophole" would be a disaster in certain situations.

For example, the $500,000 exclusion might not be enough for a highly-appreciated home. By forcing his ex to buy him out, the departing spouse can take all his gain immediately with no taxation at all. On the other side, the spouse who stays in the home can restore the full exclusion when she remarries, and she cuts her ex out of any continued rise in property value.

[jainen]

divorce is routine

To expand on my last comment--

What if the property value goes up some more in the ten years before the kids graduate? If the absent spouse has remained on title, he'll get his exclusion against that and he'll also get half of the gain. The resident spouse doesn't care about her ex's exclusion. If she took full title at the time of divorce, she has to pay 15% tax but that's better than giving 50% away. And by getting married again, she can restore the full 500K exclusion even if she doesn't share with her new guy.

For the one who left, there might also be distinct advantages in making a clean getaway. Nothing beats ten years of children for bringing down condition and value of a suburban home. Maybe he has some other way to use the money if he cashes out early -- getting a new upscale bachelor pad that provides all sorts of amenities while it gains value like nobody's business.

So my point is just that the "loophole" could be a bear trap. Nothing in a divorce is routine.

[RJM]

agree with Jainen

I agree...there are so many unusual circumstances in divorces it is best to get tax planning advice from a tax attorney or CPA that works with these situations routinely, at least when any significant assets exist, like businesses or expensive homes. I think it is worth buying some extra advice when the consequences of mistakes can be really expensive. -Bob

[New York Enrolled Agent]

I agree...there are so many unusual circumstances in divorces it is best to get tax planning advice from a tax attorney or CPA that works with these situations routinely, at least when any significant assets exist, like businesses or expensive homes. I think it is worth buying some extra advice when the consequences of mistakes can be really expensive. -Bob

I agree - "... from a tax attorney or CPA or enrolled agent that ... "

[OldJack]

that works with these situations routinely

Since when is anything we do "routine".