For many couples in Sugar Land, River Oaks, The Woodlands, Katy, and across Greater Houston, the house is the biggest single decision in the divorce. The emotional question is who stays. The financial question is what each option really costs after taxes, and the answer is often different from what the settlement spreadsheet shows.
The Texas Property Law Framework
A home bought during the marriage is presumed community property under Texas Family Code §3.003. A home owned before marriage, or received by gift or inheritance, is separate property if it can be traced, although the community may have a reimbursement claim if community funds paid down its mortgage or improved it (Texas Family Code §3.402).
The court divides the community estate in a manner it deems just and right (Texas Family Code §7.001). That does not have to be equal. Courts may consider factors such as each spouse’s earning capacity, health, the needs of children, and, in some cases, fault in the breakup of the marriage.
The Home Sale Exclusion: $250,000 or $500,000
Under IRC §121, a taxpayer may exclude up to $250,000 of gain on the sale of a principal residence, or up to $500,000 for married couples filing jointly, if:
- the taxpayer owned the home for at least two of the five years before the sale, and
- used it as a principal residence for at least two of those five years.
For the $500,000 joint exclusion, either spouse may meet the ownership test, but both must meet the use test. Generally, the exclusion can be used only once every two years.
A Corrected Example
Hypothetical: A couple bought their Sugar Land home for $300,000 and made no capital improvements. It is now worth $900,000, a $600,000 gain.
| Scenario | Gain | Exclusion | Taxable gain |
|---|---|---|---|
| Sold while married, filing jointly | $600,000 | up to $500,000 | about $100,000 |
| Sold after divorce, still co-owned 50/50, both meet the tests | $300,000 each | up to $250,000 each | about $50,000 each, $100,000 combined |
| Awarded to one spouse, who later sells alone | $600,000 | up to $250,000 | about $350,000 |
The takeaway: the cost is not driven by the date of the divorce alone. It is driven by who ends up holding the gain. When one spouse keeps the house and the other receives cash, the spouse with the house may also be taking on a deferred tax liability. That should be valued and negotiated.
Keep receipts for capital improvements. They increase basis and reduce taxable gain.
Keeping the House: Carryover Basis
Transfers between spouses incident to divorce are generally nontaxable under IRC §1041. The spouse who receives the house keeps the couple’s original basis. There is no tax on the transfer, but the built-in gain transfers along with the house.
Two federal rules help the spouse who keeps the home:
- Ownership tacking. Under IRC §121(d)(3)(A), a spouse who receives the home from a spouse or former spouse in a §1041 transfer includes the transferor’s period of ownership.
- Prior use still counts. The years the spouse lived in the home during the marriage count toward the two-year use test.
The Special Divorce Rule for the Spouse Who Moves Out
The spouse who moves out but keeps an ownership interest, for example in a deferred sale, can lose the exclusion if more than three years pass before the sale. IRC §121(d)(3)(B) addresses this. Solely for purposes of §121, a person is treated as using the property as a principal residence during any period of ownership while the spouse or former spouse is granted use of the property under a divorce or separation instrument. Treasury regulations add that the spouse or former spouse must actually use it as a principal residence.
The practical point: if a deferred sale is part of the plan, the decree or agreement should expressly grant the occupying spouse the use of the home. That language can protect the departing co-owner’s exclusion.
Deferred Sale Arrangements
Couples with children sometimes agree that one spouse will live in the home until a set date or event, then sell and divide the proceeds. These arrangements should address:
- who pays the mortgage, taxes, insurance, and repairs
- how capital improvements are credited at sale
- what triggers a sale, and what happens if either party wants to buy the other out early
- the §121(d)(3)(B) use language described above
- what happens if the occupying spouse remarries or moves
Capital Gains Rates and the 3.8 Percent Tax
Gain not covered by the exclusion is generally taxed at long term capital gains rates of 0, 15, or 20 percent federally, depending on taxable income. Higher income taxpayers may also owe the 3.8 percent Net Investment Income Tax on taxable gain, which applies above modified adjusted gross income thresholds of $200,000 for single filers and $250,000 for married couples filing jointly. For executives and professionals, the combined federal rate on taxable home sale gain can reach 23.8 percent.
If any part of the home was used as a rental or home office for which depreciation was claimed, that depreciation is generally taxable on sale even if the rest of the gain is excluded.
Ongoing Costs of Keeping the Home
Keeping the home also means carrying the mortgage, property taxes, insurance, and maintenance on one income. Property tax burdens vary widely across Harris, Fort Bend, and Montgomery counties depending on the taxing units that apply, including school districts and municipal utility districts. Federal deductions for mortgage interest and state and local taxes are subject to limits under current law, so the after tax cost should be modeled with a tax professional.
If the mortgage is in both names, also read How to Handle Mortgaged Properties in Texas Divorce.
Questions to Answer Before You Decide
- What is the adjusted basis, including documented improvements?
- How much gain would be excluded if sold now versus later, and by whom?
- Who will hold the built-in gain under each proposal, and has it been priced in?
- Can the spouse keeping the home refinance or carry the costs alone?
- If there is a deferred sale, does the decree include the use language that protects both spouses’ exclusion?
Frequently Asked Questions
Do we have to sell the house before the divorce to get the $500,000 exclusion? To use the joint $500,000 exclusion, you generally must file a joint return for the year of sale. But if you remain co-owners after the divorce and each meets the tests, each of you may exclude up to $250,000 on your share, which can produce a similar total.
I moved out. Can I still exclude my share of the gain when the house sells? Possibly. You may still meet the two-out-of-five-year use test if the sale happens soon enough, and IRC §121(d)(3)(B) can treat your former spouse’s use under a divorce or separation instrument as your use while you remain an owner.
Is there tax when my spouse deeds the house to me in the divorce? Generally no, under IRC §1041. You take over the existing basis.
Talk to a Houston Divorce Lawyer About Your Home
Anunobi Law helps clients see the after tax picture before they agree to keep or sell. We serve homeowners in Sugar Land, River Oaks, the Houston Heights, Houston, Katy, Fulshear, The Woodlands, Spring, Cypress, Pearland, Missouri City, Richmond, Humble, and Conroe. Call 832-538-0833 for a confidential consultation.
Related Reading in Our Real Estate Divorce Series
- Real Estate Divorce Lawyer in Houston: How Texas Divides Homes, Rentals, and Investment Property
- How to Handle Mortgaged Properties in Texas Divorce
- The Complexity of Vacation Home Division and Timeshare Agreements
- The Impact of Property Appreciation During Marriage in Texas Divorce
- Real Estate Investment Trusts (REITs) and Divorce Implications
- How Property Transfers Affect Your Tax Situation
Legal Disclaimer: This article is for general informational purposes only and is not legal or tax advice. Examples are hypothetical and simplified. Reading this article or contacting Anunobi Law does not create an attorney-client relationship. Consult a licensed Texas attorney and a qualified tax professional about your situation.