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Selling a house after divorce.

A husband and wife owned a principal residence with an adjusted basis of $150,000. They sold their home for an adjusted sales price of $250,000 and realized a $100,000 gain. They elected to defer the gain under Internal Revenue Code section 1034. Within a year, they separated and divorced. Within the two-year replacement period of section 1034, the husband used his share of the sales proceeds and purchased a new home for $120,000. The ex-wife did not buy another home. What was the husband's recognized gain?

In William H. Murphy v. Commissioner(lO3 TC, 111, 1994), the Tax Court said that the husband would be taxed on only $5,000. The court, citing revenue ruling 74-250 (1974-1 C.B. 202), said the nonrecognition provisions of section 1034 should be applied separately to each divorced spouse. Using this approach, the husband was treated as having sold a $125,000 home with a basis of $75,000 for a realized gain of only $50,000. Since he reinvested $120,000 of his share of the sales proceeds, the husband was taxed on only the $5,000 that he did not reinvest.

In Murphy, the IRS unsuccessfully had argued that the husband and wife should be treated as one taxpayer. The IRS had argued that the husband should be taxed on the entire gain of $100,000 because the adjusted selling price of the old home ($250,000) exceeded the replacement cost of the new home ($120,000) by $130,000 which was more than the realized gain of $100,000.

The IRS recently admitted defeat and agreed with the ruling in Murphy (Actions on Decisions 1996-007). The IRS said the court's reliance on revenue ruling 74-250 "yielded an equitable result in harmony with the ruling's intended result."

Observation: CPAs should be aware the Tax Court in Murphy agreed with the IRS that, according to IRC section 6013(d), the husband was still jointly and severally liable for the tax on the wife's gain of $50,000 if she didn't pay it. To avoid this problem, CPAs should advise clients who are contemplating divorce to consider filing separate returns or to set aside in escrow at the time of the divorce enough cash to cover any future tax liabilities relating to a former spouse.

--Michael Lynch, CPA, Esq., Associate professor of accounting at Bryant College, Smithfield, Rhode Island.
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Article Details
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Author:Lynch, Michael
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Nov 1, 1996
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