Selling a House After Divorce: Exclusion Rules, Basis, and Capital Gains

When you sell the house after a divorce, taxes work like this: the transfer of the home between you and your former spouse is tax-free, but the eventual sale to an outside buyer can trigger capital gains tax on any profit above a $250,000 per-person exclusion. The gain is measured from what you and your spouse originally paid for the home, not from what it was worth at the divorce. Selling a house after divorce taxes well means protecting that exclusion, tracking your real cost basis, and knowing which extra taxes can land on top of the standard capital gains rate.

The $250,000 Exclusion and How Divorce Timing Affects It

Section 121 of the Internal Revenue Code lets you exclude up to $250,000 of gain from selling your primary residence if you file single, head of household, or married filing separately. A married couple filing jointly can exclude up to $500,000.¹ To qualify, you must have owned the home and used it as your primary residence for at least two of the five years before the sale.

Two timing scenarios cover most divorcing couples. Sell while still legally married and file a joint return for that year, and you can claim the full $500,000 exclusion on that joint return, provided both spouses meet the use test and at least one meets the ownership test. Sell after the divorce is final, and each of you files individually and claims up to $250,000 against your own share of the gain. The combined ceiling is the same $500,000 either way, so the timing itself usually does not change the bottom line. What changes it is whether one spouse has trouble meeting the use test after moving out, which the next section addresses.

Why Your Basis Is the Original Purchase Price, Not Today’s Value

This is where divorced sellers get the biggest surprise. When a divorce decree transfers the home from one spouse to the other, no tax is owed on that transfer. Under Section 1041, any transfer of property between spouses or former spouses that is “incident to the divorce” is treated as a gift for tax purposes, so no gain or loss is recognized by either party.² A transfer qualifies if it happens within one year after the marriage ends, or within six years if it is made under a divorce or separation instrument.³

The tax is not erased by this rule. It is deferred. The recipient spouse inherits the transferor’s adjusted basis, called a carryover basis. The home’s market value at the time of the divorce is irrelevant.²

Your adjusted basis starts with what you originally paid for the home and adds the cost of capital improvements over the years. Capital improvements are substantial upgrades that add value or extend the home’s life, such as a new roof, an addition, or a kitchen renovation. Routine repairs and maintenance do not count. If either spouse claimed depreciation for business or rental use of part of the home, that depreciation reduces the basis.⁴

Here is the bite. If the couple bought the home for $200,000, added $50,000 in improvements, and the home is now worth $800,000, the recipient spouse’s basis is still only $250,000. The potential taxable gain is $550,000 minus selling expenses, not the difference between the divorce-date value and the sale price. Collect every receipt and closing document you can find from the original purchase and from improvements over the years. Without documentation, you may end up reporting more gain than you actually owe.

Divorce-Specific Rules That Protect the Exclusion

Divorce creates a problem the tax code anticipated: one spouse typically moves out, which could blow the two-year use requirement. Two special rules keep that from happening, and one partial-exclusion rule covers short ownership.

Ownership Tacking

If you received the home from your former spouse under a Section 1041 transfer, you can count the time your former spouse owned the property as your own ownership period.¹ If the couple owned the home for six years before the transfer, you satisfy the two-year ownership test immediately, even if you held sole title for a month before selling.

Use Credit for the Spouse Who Moved Out

Under Section 121(d)(3)(B), a spouse who no longer lives in the home is still treated as using it as their principal residence during any period they own it, as long as the former spouse is granted use of the home under a divorce or separation instrument.¹ The operative phrase is “granted use under a divorce or separation instrument.” A qualifying instrument includes a divorce decree, a written separation agreement, or a court order requiring spousal support payments.⁴

If your agreement does not explicitly grant your former spouse the right to live in the home, ask your attorney to add that language before the sale closes. Including it costs nothing. Leaving it out can cost tens of thousands in lost exclusion.

Partial Exclusion for Short Ownership

If you do not meet the full two-year use or ownership requirement, you may still qualify for a partial exclusion when the sale happens because of a divorce, a change in employment, health reasons, or other unforeseen circumstances.¹ The reduced exclusion is calculated as a fraction of $250,000 based on how much of the two-year period you actually satisfied. Lived there 18 of the required 24 months? You can exclude up to $187,500, which is 75% of $250,000.

The Buyout Trap: Keeping the House Means Keeping the Tax Bill

In many divorces, one spouse keeps the home by paying the other for their equity share. That buyout payment is tax-free to both sides as long as it qualifies as a transfer incident to the divorce under Section 1041.² The spouse receiving $150,000 for a half interest does not report it as income. The spouse paying it does not get a deduction.

Here is what trips people up: the buying spouse’s basis does not increase by the buyout amount. Because the transfer is treated as a gift, the carryover basis rule applies. If the home’s total adjusted basis was $250,000, the spouse who keeps it still has a $250,000 basis after paying $150,000 to buy out the other half. That buyout essentially purchased a future tax liability. When the keeping spouse eventually sells to a third party, the gain is calculated from the original $250,000 basis, not from a basis inflated by what they paid their ex.

This should factor into divorce negotiations. The spouse keeping the home inherits a potentially large embedded tax bill the departing spouse avoids entirely. A financially informed settlement adjusts the buyout price or other asset divisions to account for it.

Selling Expenses That Reduce Your Gain

Your taxable gain is not just sale price minus basis. The IRS lets you subtract selling expenses from the sale price first to arrive at your “amount realized,” and only then do you subtract basis.⁴

Qualifying selling expenses include real estate agent commissions, legal fees, advertising costs, and transfer or stamp taxes you paid as the seller. If you paid loan charges that would normally be the buyer’s responsibility, those count too.⁴ On a $500,000 sale with a typical 5% to 6% commission, that is $25,000 to $30,000 knocked off the gain before the exclusion applies. Track every closing cost.

Rates on the Portion That Is Taxable

Gain above your exclusion is taxed as a long-term capital gain, assuming you owned the home more than a year, which is almost always true. Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your total taxable income.⁵ For 2026, the 0% rate applies to single filers with taxable income up to $49,450 and joint filers up to $98,900. The 15% rate covers most middle- and upper-middle-income taxpayers, and the 20% rate applies above $545,500 for single filers or $613,700 for joint filers.⁶

After divorce, you are filing as single or head of household, so the brackets are narrower than when you filed jointly. A gain that would have been taxed at 0% on a joint return might land in the 15% bracket on a single return.

The 3.8% Net Investment Income Tax

This is the tax divorced home sellers most often miss. On top of the regular capital gains rate, a 3.8% net investment income tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds $200,000 for single filers or $125,000 for married filing separately.⁷ These thresholds are not adjusted for inflation.

Capital gain from selling a home counts as net investment income to the extent it is not excluded under Section 121. If you have $50,000 of taxable gain after your exclusion and your income pushes you above $200,000, that $50,000 can face the 3.8% surtax on top of the 15% or 20% rate, bringing your effective rate to 18.8% or 23.8%. It is reported on Form 8960.

Depreciation Recapture on Home Office or Rental Use

If either spouse claimed depreciation on part of the home for a home office or rental use, the Section 121 exclusion does not cover the gain attributable to that depreciation. That portion is taxed at up to 25% as unrecaptured Section 1250 gain, regardless of your bracket.⁸ Even if your total gain is below the $250,000 exclusion, the depreciation portion is carved out and taxed separately.

The amount subject to recapture is depreciation allowed or allowable after May 6, 1997. “Allowable” means you owe this tax even if you forgot to claim depreciation deductions you were entitled to. The carryover basis rule means this liability follows the home to whichever spouse ends up selling it.⁸

Reporting the Sale and Splitting the Gain

The closing agent issues IRS Form 1099-S reporting the gross sale price. It goes to whoever is listed as the seller on the closing documents, which may be one or both former spouses, and it shows only gross proceeds, not your basis, selling expenses, or exclusion.⁹

Each former spouse reports the sale on Form 8949, Part II, and carries the totals to Schedule D of their individual return. Even if your entire gain is excluded, you still report the sale on Form 8949 and show the exclusion as a negative adjustment in column (g).¹⁰ Skipping that step triggers IRS notices, because the agency sees a 1099-S showing hundreds of thousands in proceeds and no matching entry on your return.

How to Split It Between You

If both spouses are on the deed and the agreement splits proceeds 50/50, each reports half the sale price, claims half the basis, and subtracts half the selling expenses. Each then applies their own $250,000 exclusion against that share. For an unequal split, the gain allocation follows the same ratio spelled out in the agreement. When the agreement is silent, the default is typically each spouse’s ownership interest, but ambiguity invites IRS questions when the numbers on two former spouses’ returns do not match. Get the allocation in writing.

A quick example. The home sells for $700,000. Combined adjusted basis is $250,000, and selling expenses total $40,000. Amount realized is $660,000, total gain is $410,000. Split equally, each former spouse has a $205,000 gain, which falls under the $250,000 exclusion, so neither owes capital gains tax. If total gain were $600,000, each spouse would have a $300,000 gain, resulting in $50,000 of taxable gain per person after each applies the $250,000 exclusion.

1
Office of the Law Revision Counsel. 26 U.S. Code 121 – Exclusion of Gain From Sale of Principal Residence
2
Office of the Law Revision Counsel. 26 U.S. Code 1041 – Transfers of Property Between Spouses or Incident to Divorce
3
eCFR. 26 CFR 1.1041-1T – Treatment of Transfer of Property Between Spouses or Incident to Divorce
4
Internal Revenue Service. Publication 523 (2025), Selling Your Home
5
Internal Revenue Service. Topic No. 409 Capital Gains and Losses
6
Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates
7
Office of the Law Revision Counsel. 26 U.S. Code 1411 – Imposition of Tax
8
Internal Revenue Service. Property (Basis, Sale of Home, Etc.) 5
9
Internal Revenue Service. Instructions for Form 1099-S
10
Internal Revenue Service. Instructions for Form 8949 (2025)