Sale of the marital residence in a divorce context.

• Author: Cunningham, Joseph W.

The tax relief provisions under which gain from the transfer of a principal residence may be either deferred (Sec. 1034) or excluded (Sec. 121) may come into play within the context of divorce planning.

Deferral of gain under Sec. 1034

Sec. 1034 provides for the deferral of gain from the sale of a residence if the sale proceeds are reinvested in a new principal residence within two years before or after the sale date. If a residence is owned jointly and sold by a divorcing husband (H) and wife (W), Sec. 1034 deferral is available to each of them separately (Rev. Rul. 74-250). If either H or W remarries and jointly purchases a residence with his or her new spouse, the new residence qualifies as a Sec. 1034 reinvestment only to the extent of the interest held by the reinvesting spouse.

Care must be exercised when a taxpayer intends to defer gain from a previous sale by purchasing an interest in a home already owned by a prospective new spouse. If the purchase is made after the marriage, it will be treated as a "gift" for tax purposes under Sec. 1041, regardless of the consideration paid, and thus will not be a qualifying purchase under Sec. 1034. If the purchase is made before the marriage, it will be a purchase qualifying for Sec. 1034 deferral relief, but will also, correspondingly, be a taxable sale by the "newly intended."

If spouses separate and one moves out of the marital home, the departing spouse may no longer qualify for Sec. 1034 relief when the residence is later sold, since the old house (as well as the new) must be the seller's "principal residence." Whether the old house remains the "principal residence" of a physically separated spouse is a subjective determination based on all the facts and circumstances (Regs. Sec. 1.1034-1 (c)(3)(i)). The criterion most often considered is whether the taxpayer moved out of the home with an intent to return; see, e.g., Rev. Rul. 78-146. It may be advisable for a spouse who has vacated the family home, but who may return, to continue to use that address for voter and driver's license registrations, etc., to help preserve the home's character as his or her "principal residence."

Exclusion of gain under Sec. 121

Sec. 121 provides for an elective once-in-a-lifetime exclusion of up to $125,000 of gain from the sale of the principal residence of an individual who his reached 55 years of age, and who has owned and resided in the house for three of the preceding five years. The timing of the sale...