Greater Boston real estate has experienced historic appreciation over the past decade. While high property values mean significant equity for divorcing homeowners, they also bring an often-overlooked tax risk: Capital Gains Tax.
Under IRS Section 121 (which Massachusetts adopts for state tax calculations), homeowners can exclude a portion of their profit from income tax when selling a primary residence. However, how and when you structure your sale during a divorce determines whether you protect that equity or hand a large portion over to the government.
The $500,000 vs. $250,000 Rule
To qualify for the primary residence exclusion, you must have owned and lived in the home for at least two of the five years preceding the sale:
- Married Filing Jointly: Qualifying couples can exclude up to $500,000 in capital gains profit.
- Single Filers: An individual can exclude up to $250,000.
In high-value communities like Brookline, Lexington, or Concord, it is common for a home purchased years ago for $700,000 to sell today for $1.6 million—generating $900,000 in net profit.
Two Common Traps to Avoid
- Selling Post-Divorce as Single Filers: If you finalize your divorce first and sell the home later as co-owners filing single returns, you each get a $250,000 exclusion ($500,000 combined). However, if total profits exceed $500,000, any remaining gain above that threshold is exposed to federal and state capital gains taxes. Selling before finalizing the divorce (or while still eligible to file jointly) often preserves the full $500,000 umbrella.
- The “Vacated Spouse” Trap: If one spouse moves out of the home during separation while the other stays for several years (e.g., until the youngest child graduates high school), the departing spouse may lose their primary residence status if they haven’t lived there for 2 out of the previous 5 years.
The Solution: Your family law attorney can include specific language in the separation agreement stipulating that the resident spouse’s occupancy counts toward the non-resident spouse’s “use test” under IRS rules.
Consult Your Professional Team Early
Before signing a separation agreement or deciding who keeps or sells the house, evaluate your original cost basis—including capital improvements made over the years. As a Certified Divorce Specialist®, I work alongside your legal counsel and CPA to ensure property decisions prioritize equity preservation. Always consult your attorney and accountant to determine the right path for your situation.
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