Capital Gains, Tax Exclusions & What You Need to Know
If you and your spouse own a home together, the question of what to do with it is almost certainly on the table. Maybe one of you wants to stay. Maybe selling makes the most financial sense. But here’s what most people don’t realize until it’s too late: how and when you sell your marital home during a divorce can have significant federal tax consequences.
Michigan divorcing homeowners frequently ask about the marital home, who moves out, who gets it, how it’s divided. What almost never gets covered is the tax side of selling. That gap can cost you tens of thousands of dollars if you’re not careful.
This article breaks down capital gains taxes on home sales during divorce, Michigan-specific considerations, the IRS exclusion rules you may be entitled to, and how the timing of your divorce can affect your bottom line.
What Is Capital Gains Tax on a Home Sale?
When you sell your home for more than you paid for it, the profit is called a capital gain. The IRS taxes this gain, sometimes significantly, unless an exclusion applies.
Here’s a simplified example: If you and your spouse bought your Downriver home for $180,000 in 2012 and sell it for $330,000 during your divorce in 2026, you have a $150,000 capital gain. Without any exclusion, that gain could be taxed at 15% to 20%, meaning you could owe the IRS $22,500 to $30,000 right when you’re trying to rebuild your financial life.
The IRS Section 121 Exclusion & How Divorce Changes Everything
Under IRS Section 121, married couples filing jointly can exclude up to $500,000 in capital gains from the sale of their primary residence. Single filers get a $250,000 exclusion.
To qualify, you generally must have:
• Owned the home for at least 2 of the last 5 years (the ownership test)
• Lived in the home as your primary residence for at least 2 of the last 5 years (the use test)
• Not used the exclusion on another home sale within the past 2 years
This sounds straightforward. But divorce creates three scenarios where the rules get complicated, and expensive, if you get them wrong.
Scenario 1: You Sell the Home Before the Divorce Is Final
This is often the cleanest option from a tax standpoint. If you sell the home while you are still legally married, you can potentially claim the full $500,000 joint exclusion, as long as both of you meet the ownership and use tests.
The catch: you must file your taxes jointly for that tax year to claim the full $500,000. If your divorce is finalized before December 31st of the year you sell, you will file as single filers and each only gets the $250,000 exclusion.
Practical tip: If your home sale will generate a large capital gain, your attorney should coordinate the timing of the sale and the finalization of your divorce with a tax professional. Saving $50,000 in taxes might be worth waiting a few weeks to close the divorce.
Scenario 2: One Spouse Stays In The Home, Then Sells Later
This is extremely common in Michigan divorces, especially when minor children are involved. One spouse, often the custodial parent, remains in the marital home until the children finish school or another milestone is reached.
Here’s the tax problem: the spouse who moves out may lose their ability to claim the Section 121 exclusion over time. Remember, you need to have lived in the home as a primary residence for 2 of the last 5 years. If the departing spouse moves out in 2024 and the home is sold in 2030, they’ve failed the use test and could owe capital gains tax on their share of the profit.
There is a partial fix. Under IRS rules, a spouse who is granted use of the home under a divorce or separation agreement can tack the other spouse’s use period onto their own for purposes of the exclusion. But only the resident spouse benefits; the non-resident spouse still needs to have used the home within 5 years of the sale.
This means the longer one spouse stays in the home post-divorce, the worse the tax outcome for the non-resident spouse. This is a critical reason to include a sale timeline in your divorce settlement, not just a vague agreement that the home will “eventually” be sold.
Scenario 3: One Spouse Buys Out The Other
In a buyout scenario, one spouse pays the other for their share of the home’s equity and keeps the home. From a tax standpoint, the departing spouse is effectively selling their interest in the property.
The good news here: if both spouses meet the use and ownership tests at the time of the buyout, the departing spouse should be able to claim up to their $250,000 share of the joint exclusion, potentially making the buyout completely tax-free up to that amount.
The buyout amount used in divorce negotiations should account for the tax implications on both sides. A buyout that looks even on paper may actually be unequal once taxes are factored in.
Michigan-Specific Considerations
Property Transfer Tax
Michigan imposes a State Real Estate Transfer Tax of $3.75 per $500 of value (0.75%) and a County Transfer Tax of $1.10 per $500 (0.22%) on most property transfers. However, transfers between spouses pursuant to a judgment of divorce or separate maintenance are generally exempt from Michigan transfer tax. This means that a deed transfer from joint ownership to one spouse’s name in connection with a divorce typically triggers no transfer tax, but the paperwork must reference the divorce decree properly.
Homestead Property Tax Exemption
Michigan’s Homestead Exemption reduces your property taxes on your primary residence. If one spouse moves out and stops claiming the property as their primary residence, they lose this benefit. If the home is later refinanced or assessed, there can be a “pop” in taxable value that surprises the remaining spouse. Address the homestead exemption explicitly in your divorce settlement.
Downriver Real Estate Market
In Wayne County and the broader Downriver area, communities like Wyandotte, Southgate, Trenton, and Flat Rock, home values have appreciated significantly over the past decade. A home purchased 10-15 years ago at a low price may now carry a capital gain that makes the tax exclusion rules extremely relevant. Don’t assume your gain is too small to matter until you’ve actually run the numbers.
Common Questions: Selling the House in a Michigan Divorce
Do I have to sell my house in a Michigan divorce?
No. Michigan courts can order a sale, allow one spouse to buy out the other, or grant the home to one spouse as part of the property division. However, if spouses cannot agree, a judge will decide — and courts often order a sale when neither spouse can afford the home alone or when the equity needs to be divided.
What if we’re underwater on the mortgage?
If you owe more than the home is worth, selling at a loss creates its own set of complications, including potential deficiency liability and the question of how to allocate the loss between spouses. A short sale is sometimes an option, but it requires lender cooperation and has its own tax consequences (potential cancellation of debt income).
Can we sell the house quickly to make the divorce go faster?
Yes, and for some couples a fast sale — even at a slight discount — is worth the savings in attorney fees and emotional energy. However, rushing a sale to close the divorce before December 31st of a given year can affect which tax exclusion you qualify for. Get advice before rushing.
What if one spouse refuses to sign the sale documents?
In Michigan, a court can appoint a receiver or issue an order requiring a spouse to execute documents related to the sale. Refusing to cooperate with a court-ordered sale can have serious legal consequences. Your attorney can file a motion to enforce the settlement or court order.
Selling Your Home During A Divorce
The marital home is often the largest asset in a Michigan divorce — and the tax implications of selling, transferring, or retaining it are often the largest financial variable that goes unaddressed. Whether you’re in the early stages of divorce or finalizing a settlement, make sure your attorney and a qualified tax professional have both reviewed the home situation together.
At The Mitten Law Firm, we serve divorcing clients throughout Wayne County and the Downriver area, including Wyandotte, Southgate, Taylor, Trenton, Grosse Ile, and surrounding communities. If you have questions about property division in your Michigan divorce, contact us for a free consultation.