Divorce Taxation – Part IV

Originally published in the Pacific Grove Hometown Bulletin

July 18, 2012

Asset Transfers

Splitting up assets in a divorce can create some interesting situations where special tax laws apply.  For instance, any assets transferred between spouses within one year of a divorce are considered transferred incident to divorce and are tax-free transfers.  In such a situation, no gain or loss is recognized, and the adjusted basis transfers from one spouse to another just like a gift, even if the property transfer was not stipulated by the divorce decree.

Some strange outcomes can occur from this law.  Theoretically, you could have a situation where spouse A has $20,000 worth of stock certificates that were bought for $5,000 many years ago.  Spouse A sell the stock to Spouse B for $20,000 nine months after they are divorced.  Spouse A would recognize no capital gain on the sale and pay no tax.  Instead, Spouse B would receive a basis of $5,000 (instead of $20,000) and then owe the tax on any gain from a future sale that one would normally think belonged to Spouse A.  Ouch – this could bite the ill-informed!  These same laws, however, could be used in a positive manner for planning purposes.  For instance, if spouse A needed cash, and spouse B had large capital loss carryforwards that were likely to go unused, they could work out an arrangement to their joint benefit.

If property is stipulated to be transferred by a divorce decree, the tax-free transfer laws apply for six years.  Beyond six years, the tax-free transfer laws can still be applied if facts and circumstances support the idea that the transfer was carrying out the division of property stipulated by a divorce decree.

Sometimes, it is not always clear what qualifies as property for the asset transfer rules.  For instance, transferring the right to receive future income can be a gray area.  There are also other exceptions to the rules such as when trusts or nonresident aliens are involved, etc.  It is always best to get sound advice before acting!

Court Orders

It is also important to remember that a court order is a controlling document.  Generally speaking, whatever is decided in a court order will govern and override any default tax laws that would otherwise control.  It is best to seek competent tax and legal advice, so you have a clear idea of what to expect, and have the opportunity to negotiate the tax aspects of your settlement.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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