Apparently, the IRS — or maybe the Congress that wrote the tax law; it’s unclear in this case — thinks it’s a good idea for couples to live together before they get married. Such a good idea, in fact, that married couples who lived together before they got married get a tax benefit not available to married couples who wait to live together until they get married. In fact, by marrying without living together first, one can even lose a tax benefit one would have had by remaining single!
Here’s the story: If you sell a house that’s your primary residence for more than you paid for it, you don’t have to pay tax on the first $250,000 of gain if you are single, or the first $500,000 if you are married (filing jointly). However, there are requirements for defining “primary residence,” and also, you can only take the exclusion once every two years, regardless of your marital status at each point in time.
Now, here’s the benefit for illicit co-habiters:
Either spouse can meet the ownership test. For example, the IRS says it’s OK if you owned the home for the last two years, but you just added your new husband to the title when you got married six months ago. Since you owned the residence for the requisite time, as joint filers you have no problem meeting the ownership test even though your husband wasn’t an official owner for that long.
However, both husband and wife must pass the use test; that is, each must live in the residence for two years. But the shared use doesn’t have to be while you file jointly. If you and your now-husband shared the home for 1½ years before tying the knot and then six months as newlyweds, the IRS will allow you to claim the exemption. But if he didn’t move in until the wedding day, you’re out of tax-exclusion luck.
Furthermore, marrying can deprive you of the exemption altogether, if you marry someone who’s “done it” before (i.e., sold a house within the last two years — what were you thinking?):
And while you’re learning about your new spouse, make sure you find out all about his or her previous home-sale history. “The two-year eligibility rule applies to both spouses, so full home disclosure is another financial area you need to consider when getting married,” says Trinz. “You need to find out what you’re getting.”
Right. So in addition to making sure your future spouse didn’t fool around with other people before getting married (and pick up any diseases), you have to make sure he/she didn’t fool around with any real estate agents and pick up any home-sale tax exclusions!
Under this couple requirement, if either spouse sold a home and used the exclusion within two years of the sale of any jointly-owned property, the couple can’t claim the exclusion. That means if your new husband sold his townhouse a month before the wedding, then you’ll have to wait two years after that property’s sale date before you can dispose of your shared marital residence tax-free.
So if you marry the “wrong person,” you lose the $250,000 exemption you would have had if you stayed single (with or without co-habiting). But if you marry the “right person,” your exclusion doubles immediately — provided you co-habited that person for at least two years first!
Remember this next time someone tried to convince you that the tax code encourages “traditional marriage” …
