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Vacation houses, divorce settlements and tax implications

On Behalf of | Aug 21, 2023 | DIVORCE - High-Asset Divorce

Marriage often comes with dreams of shared adventures. For many, owning a vacation home becomes a tangible extension of those dreams. These second homes can become an escape from the hustle and bustle of daily life. However, untangling the ownership of these properties during a divorce can raise several tax implications that need careful consideration.

Primary residence vs. second home

It is important to differentiate between a primary residence and a second home when dealing with vacation homes in divorce. A primary residence is the main home where you live most of the time, while a second home is typically a vacation property. The tax implications differ depending on which category the property falls into.

Capital gains tax on second homes

Capital gains tax might apply if you and your spouse decide to sell a vacation property as part of your divorce settlement. You may calculate capital gains tax based on the difference between the property’s sale price and its original purchase price. However, you can reduce or eliminate the tax burden if the property qualifies for the primary residence exclusion.

Primary residence exclusion

Under the primary residence exclusion rule, if the vacation home was your primary residence for at least two out of the last five years, you might be eligible to exclude up to $250,000 of capital gains from taxation ($500,000 for married couples filing jointly). To qualify, you must meet certain ownership and usage requirements. However, keep in mind that this exclusion only applies once every two years.

Transfer of ownership and gift tax

In some cases, one spouse might keep the vacation home while the other receives other assets of comparable value. This transfer of ownership can have gift tax implications.

Although California does not enforce a gift tax, you may be subject to a federal one. According to IRS rules, if the property’s value exceeds the annual gift tax exclusion, the excess amount could count against the lifetime gift and estate tax exemption.

When it comes to divorce settlements involving vacation homes, you cannot put the intricacies of tax implications on the side. Remember that your future financial well-being depends on making the right choices. Consider seeking guidance from a tax advisor or an attorney to ensure you are aware of these implications before making a decision.