Most married couples take their special tax benefits as property owners for granted. But gay and lesbian couples who tie the knot in California or Massachusetts may not be able to take full advantage of certain property-related tax breaks because federal law doesn’t recognize their marriage.
California and Massachusetts now consider so-called “same-sex” marriages to be equivalent to traditional, now so-called “opposite sex,” marriages. However, federal agencies, such as the Internal Revenue Service, must take their cue from the 1996 Defense of Marriage Act, or DOMA, according to John W. Roth, a senior tax analyst with tax-software provider CHH Group. DOMA stipulates that only a marriage between a man and a woman is valid in the United States.
“If two people get married, the federal government is not interested in that until they try to take advantage of a preferential tax treatment that is granted on the basis of marital status,” says Jo Ann Citron, a Boston-based attorney who has handled same-sex divorce cases in Massachusetts. “Once they attempt to avail themselves of that, the federal government takes notice.”
- Exclusion of capital gains tax on the sale of a principal residence.
- Exemption from capital gains tax on property transfers incident to divorce.
- Temporary $7,500 tax credit, subject to recapture, for certain homebuyers.
Capital gains tax on sale of a principal residence
Federal law allows married couples who sell a home they’ve occupied as a principal residence to exclude $500,000 of their gain on the sale of that residence from capital gains tax, subject to certain rules. Single taxpayers can shield half that amount, or $250,000.
But same-sex couples who get married are treated as if they were single for federal income tax purposes. That means they can each exclude up to $250,000 of the total capital gain on the sale of their home as individuals, but they can’t exclude a combined $500,000.
“They would have to each be qualified to take $250,000,” Roth explains.
That seems straightforward, but it’s not. Suppose a same-sex married couple sold a principal residence and netted a gain of more than $250,000, but only one of the spouses earned income and filed a tax return. In that case, the total exclusion would be limited to the single taxpayer’s $250,000, even if the couple owned the property together.
Capital gains taxes on transfer of property
The federal capital gains tax can also trip up same-sex couples who get divorced, even though state law dictates how property is divided in divorce cases, Citron says.
State courts traditionally granted a divorcing couple’s family home to the wife, in large part because she often also had custody of the couple’s children. Fair or not, that scenario illustrates why federal law specifically exempts transfers of property between spouses from capital gains tax if the transfer is incident to a divorce, among other circumstances.
But because same-sex marriages aren’t recognized by federal law, same-sex divorces don’t exist either. The only divorce that exists under federal law is between a man and a woman, Roth explains.
That means if a state court orders a transfer of property between same-sex spouses who divorce, that transfer can trigger capital gains tax.
“If you get divorced, the marital home is transferred to one spouse or the other or sold. If one spouse wants to transfer property, this doesn’t trigger capital gains tax for opposite-sex married couples. If they are a same-sex couple whose marriage is not recognized by the federal government, that transaction is taxable,” Citron says.
The $250,000 capital gains exclusion can be applied, but beyond that, same-sex couples who transfer property as a result of divorce can face a hefty capital gains tax bill.
The problem can be much worse if a same-sex couple no longer resides in the state where they were married. Because other states may not recognize their marriage or have jurisdiction over their divorce, a division of marital property incident to divorce could require a lawsuit.
“The only way that they could possibly divide the property, if, say, they bought a piece of real estate jointly, would be for one partner to go into court and ask for a partition suit to break the ownership and force the other partner to buy them out. But if that were the case, capital gains tax would incur because … the marriage is not between a man and a woman,” Roth says.
First-time homebuyer tax credit
The Housing and Economic Recovery Act of 2008, signed by President Bush July 30, allows married couples to claim a $7,500 tax credit if they buy a home together and neither of them has owned a principal residence during the last three years. The credit also can be allocated into separate amounts if two people who aren’t married purchase a home together, according to the text of the law. That suggests that a same-sex couple could buy a home together and allocate the credit between them on their individual federal tax returns if neither of them owned a home during the last three years.
“Again, they are going to be filing as single and be limited to $3,750 each,” Roth says.
For purposes of this credit, a “first-time homebuyer” is defined as any individual “and if married, such individual’s spouse,” who hasn’t owned a principal residence during the prior three years. That means that if one spouse in a traditional marriage had owned a home within the prior three years, that couple would be disqualified from taking the credit. But if one spouse in a same-sex marriage had owned a home during the last three years and the other spouse hadn’t, the latter spouse presumably could still claim a portion of the credit because he or she would be considered single for federal tax return purposes.
Homebuyers should note that this tax credit is subject to a number of restrictions and must be paid back to the government unless the home is later sold at a loss.
“People usually sell their house within five to seven years, which is only about one-third to one-half of the way through the recapture period. The minute you sell that house, you are going to trigger full recapture of any credit that you claimed,” Roth warns.
Same-sex couples who marry in California or Massachusetts may also face a multitude of other legal and tax issues that arise because their home state treats their relationship differently than the federal government does. These couples are thus all the more strongly encouraged to seek advice from professionals who are familiar with these issues.
“A lot of these same-sex couples are going to have to go out and hire professional financial help,” Roth says.
Given the complexities, that specialized assistance probably won’t come cheap.
- TIR 04-17: Massachusetts Tax Issues Associated with Same-Sex Marriages
- Massachusetts Department of Revenue: Same Sex Marriages
Marcie Geffner is a freelance real estate reporter in Los Angeles.