Dividing the Family Home in a Gray Divorce: Sell, Buy Out, or Keep — and the Capital Gains Trap

For most couples over 70, the family home is the largest single asset — often worth more than all the retirement accounts combined. After 30 or 40 years of ownership, the house may have appreciated by 500,000 dollars or more above its original purchase price. That appreciation has tax consequences that catch divorcing seniors off guard if they have not thought it through.

The IRS allows a capital gains exclusion on the sale of a primary residence: 250,000 dollars per person, 500,000 dollars for a married couple filing jointly. This is from IRS Publication 523. To qualify, the home must have been the primary residence for at least two of the last five years. The exclusion is the single biggest tax break in the American tax code. The question for a divorcing couple is: how do we keep the 500,000 dollar joint exclusion when we file as single people?

The answer depends on when you sell. If the home is sold before the divorce is final, the couple files a joint return for that year and qualifies for the full 500,000 dollar exclusion. If the home is sold after the divorce, each ex-spouse files individually and the exclusion is 250,000 dollars per person — still applied to their share of the gain. If only one spouse keeps the house and lives there, that spouse keeps a 250,000 dollar exclusion when they later sell.

Three common options exist for dividing the home. Option one: sell now, split the proceeds. This is the cleanest and the one most attorneys recommend for couples over 70. Both spouses walk away with cash that funds new housing, and the tax exclusion is maximized when the sale happens during the marriage. Option two: one spouse buys out the other. The staying spouse refinances or pays cash to buy the other's interest in the home, and the leaving spouse signs a quitclaim deed transferring full ownership. The buyout amount usually equals half the home's appraised current value minus half of any remaining mortgage. Option three: continue co-owning. Less common at 70+, but used when neither spouse wants to leave and there is enough room to live separately, or when the kids want the home preserved as an inheritance. This option creates tax and legal complexity for years.

A buyout sounds straightforward but contains traps. If the staying spouse takes on the entire mortgage, the lender has to approve the assumption — at 70+, qualifying alone on a single Social Security and pension income is harder than at 45. If the buyout requires cash from a retirement account, the withdrawal is taxable. If the staying spouse later sells, the original purchase price (cost basis) is partly inherited from the marriage and partly from the buyout — a tax preparer will need to work this out carefully. The leaving spouse should make sure the divorce decree explicitly states that the home transfer is incident to divorce, which makes it a non-taxable event under IRS Section 1041.

Reverse mortgages add another complication. If either spouse has a reverse mortgage on the home, divorce changes the rules. Reverse mortgages are usually tied to the youngest borrower's age and require the home to remain a primary residence. If a non-borrowing spouse stays in the home after divorce, they may or may not retain occupancy rights depending on when the mortgage was originated. HUD's reverse mortgage page at hud.gov has the current rules. Consult an elder law attorney before signing anything.

A final consideration is property tax. Some states (California, Florida, Texas, others) freeze property tax assessments for older homeowners — but the freeze sometimes transfers cleanly between spouses and sometimes does not. The county assessor's office can confirm. A spouse who buys out the other and stays in the home should make sure the property tax exemption transfers to their sole ownership.

(Sources: IRS Publication 523 (Selling Your Home); IRS Publication 504 (Divorced or Separated Individuals); HUD reverse mortgage page at hud.gov; AARP home equity guidance, accessed May 2026)