Dear Ms. MoneyPeace, I have a question about calculating the cost base of my home.
I was married when my then-husband and I bought the house I still live in. Years later we divorced and as part of the settlement we had the house appraised at market value. I refinanced the house and paid my husband his half of the equity under the divorce settlement as I wanted to stay in the house. If I were to sell the house now, would I relate half of the cost to the original purchase price and the other half to the market value at the time of our divorce?
I assume that I would then add up the cost of any improvements. But can I add the full cost of the improvements made prior to our divorce, or can I only add half of that pre-divorce improvement cost? It would make sense if I fully add in the cost of improvements made after our divorce settlement.
It all seems complicated. Am I thinking about this calculation correctly?
Thanks very much.
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With soaring house prices and the divorce rate, you are not alone with this question. As a result of the pandemic, prices rose 16% from April 2020 to April 2021, the biggest one-year jump in 30 years.
Divorce has three major effects on capital gains.
1. Capital gains on divorce
While your thinking is logical, from the IRS perspective it is not the same as the tax implications. The basis is the original purchase price plus the full cost of any improvements made during your years of ownership.
I consulted an expert on this.
"A divorce settlement is different from buying the house from someone they share the house with," said Colleen Montgomery, founder and partner of Montgomery & Granai tax, accounting, and management consultancy firm in Burlington, Vermont. "Your ex-spouse did not tax the sale or the gains or losses."
Despite the market value at the time of the divorce, the basis does not change. Property comparisons for divorce are extensively covered by the IRS.
Let's talk about numbers. For example, you bought your house with your husband for $ 200,000 and now the house is worth $ 325,000. When you got divorced, the house was worth $ 275,000. However, the base is $ 200,000 plus skilled home improvement. Once you sell your home, the sale price minus the base is the profit or loss on which capital gains tax is to be calculated. (So, $ 325,000 minus $ 200,000 minus improvements.) If your home improvement total is $ 60,000, your profit is $ 65,000.
Read: This can save you money on capital gains tax when you sell your home
2. Exclusion of Capital Gains
The IRS gives you a $ 250,000 exclusion on all home sales profits. (Married couples get double.) You will qualify for this exclusion if you pass the property test.
The detailed tax preparation is best left to the experts; This background is meant to help explain the basics. Once you've gathered the relevant information and home improvement details, the best thing to do is to contact an accountant to process your 1040 tax return for 2021 as it will look different from previous years.
For example, whether or not you have a tax liability, you will need to report the sale to the IRS in detail. Also, you want to know your state's sales rules.
3. Divorce and financial advice
Although some have forecast a higher divorce rate due to the pandemic, the latest statistics for 2020 do not yet reflect this. In part due to disruptions and court closings, the divorce rate has been lower in the past year, in line with a trend over the past few decades.
Anyone in the process of negotiating a divorce must consider sharing the potential arrangement with their accountant and / or financial planner. You aren't the only one who didn't consult a financial planner during your divorce. Amid the stress and emotions of a divorce, these types of details seem negligible, but are vital for women or anyone else who has a solid financial footing after the divorce.
Be aware that a financial professional would have helped you consider the capital gains as additional future costs in negotiating your divorce. With legal fees soaring, some people avoid this step for fear of consulting fees. Ask your divorce attorney how they deal with the financial aspects.
CD Moriarty is a certified financial planner, MarketWatch columnist, and personal finance speaker. She blogs at MoneyPeace.