What happens to the family home at divorce?

Some families choose to defer the sale of the family residence to a later time even though their divorce is final. While the Court has discretion to order a deferred sale of home, most of the time a deferred sale of home is the result of a settlement agreement between the parties – meaning that both owners have consented to the delay of sale.

Home-owners are responsible for paying capital gains taxes on any sale of a residence. However, the IRC allows for an exclusion for taxes on up to $250,000 (for single taxpayers) or$500,000 (for married taxpayers filing jointly) from the sale of the principal residence.  IRC 121.

In order to qualify for this exclusion, the family home must be used as the primary residence for 2 of the last 5 years and the full amount can be claimed only if there was no other sale for which a §121 exclusion was claimed within two years prior to the sale date. For joint filers to obtain the full exclusion, the home must have been owned by one of them for at least two of the five years before the sale, both spouses must have used the home for two of the last five years.

For a home that is received in a §1041 transaction, the spouse may count the joint ownership time towards his or her eligibility for the exclusion.

Even if a spouse has not lived in the home for 2 years, you can preserve the $500,000 exclusion by signing and executing a Stipulation that grants one spouse the exclusive use of the home under a court order and has both spouses on title. This is called a “Duke” order and the “out-spouse” is credited with the time the other spouse has exclusive use. Make sure to specify the duration of this order because only the time pursuant to a written agreement or order will be considered under this rule.

If it’s been more than 2 years, you can re-qualify for the exclusion but the house must be held by the parties for at least 2 more years for the out-spouse to re-qualify for the exclusion.

Keep in mind that this may not apply in the case of a “bird- nesting arrangement”. This is because under §121, one party must be granted use of the property under the divorce agreement.   

Even if you did not create a written agreement, you still may be in luck. A taxpayer can qualify for a partial exclusion if they cannot meet the two out of five year requirement due to an “unforeseen circumstance”. A divorce or separation under a qualified agreement is considered an “unforeseen circumstance.”  

If you are interested in learning more about nesting you can contact me at Amanda@gordonfamilylaw.com for more information.

What is the tax basis for property transferred under IRC 1041?

What is the tax basis for property transferred under IRC 1041?

Experienced Bay Area family law attorneys will tell their clients about property transferred under IRC 1041.

Property transferred under § 1041 use a carryover basis. This means that the transfer of property is treated similarly to a gift (for income tax purposes only) from one spouse to the other.

“Basis” is the net capital investment in a property. To calculate basis, you need to find the original cost or capital investment.  For example, if you purchase a family home in 2011 for $1,300,000, the basis would be $1,300,000.  Next, you add the cost of capital improvements and depreciation.  In some cases, you are also allowed to add income that passed through the asset and to deduct or subtract the losses.  From this number you get the “adjusted basis.”

When it comes to taxation of these assets, the value used for taxation purposes (gain/loss) Is determined by subtracting the “adjusted basis” from the net amount at a sale.

In a divorce situation, parties divide property based on their current fair market values. If one spouse trades the property for another asset, they will be receiving the asset with a basis equal to the original community investment in the property and will pay taxes based on the original community investment when the asset is sold.

In negotiation over marital assets, experienced attorneys will help their clients understand that some assets are more valuable when they are looked at on an after – tax basis compared to when they are viewed on a pre-tax basis. 

Remember tax basis is not the same as debt.

It’s important to keep in mind that an asset with a low basis is usually worth less in the final settlement because of its higher tax burden. Additionally, unless taxes are “immediate and specific”, a Court may not consider the impact of tax basis of assets when dividing them.

This means that it is possible to have a division of assets which is equal according to net market value, but which is unequal when the taxes are taken into account.

For instance, consider two assets, Hawaii Rental Property and Tahoe Ski Chalet, each worth $1,000,000 but the Hawaii Rental Property has a basis of $200,000 and the Tahoe Ski Chalet has a basis of $900,000k.  If Wife gets the Tahoe Ski Chalet and Husband gets Hawaii Rental Property, the division is equal as far as the Court is concerned because each spouse received property worth $1,000,000.

However, if you look at the tax ramifications of an immediate sale, wife’s taxable gain would be $100,000 (her basis is $900,000), while husband’s gain would be $800,000 (his basis is $200,000). Wife taking the Tahoe Ski Chalet means that she ends up with the better deal and more cash. In this case, the Husband should determine if requiring the assets sold prior to division is a better strategy so that taxes can be taken into account in the overall property division

It should be noted that §1041 also applies to property that is under-water or valued at a loss.  For example, if your real estate is worth $1,400,000 but has a basis of $2,000,000, the spouse who receives the property will get the tax benefit of a built in loss. If you have Estate Planning documents in place, it’s important to note that the non-recognition treatment does not apply to negative basis property which has been transferred into an irrevocable trust, even if pursuant to a divorce.

The information set forth in this Question and Answer was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding United States federal tax penalties that may be imposed on the taxpayer.  The information was written to support the promotion or marketing of the matters addressed in this Question and Answer.  All taxpayers should seek advice based upon the taxpayer’s particular circumstances from an independent tax advisor.  The foregoing language is intended to satisfy the requirements under the regulations in Section 10.35 of Circular 230.

If you are interested in learning more, you can contact me at Amanda@gordonfamilylaw.com for more information.

Are there different rules for property division in a divorce if my spouse is not a US Citizen?

Experienced Bay Area family law attorneys will inform their clients if they are transferring property to a non-resident alien spouse.

Are there different rules for property division in a divorce if my spouse is not a US Citizen? 
Yes. A transfer to a non-resident alien spouse is specifically excluded from §1041 which means that IRC §1041 (and the rule of no tax treatment) does not apply if a transfer is TO a non-resident alien.

Non-taxable treatment does apply if the transfer is FROM a non- resident alien to a US resident or citizen. These transfers become fully taxable subject to capital gains/losses. 

Further complications can arise if a non-citizen spouse ceases to be considered a US resident before the property is fully divided and or an equalizing note is fully paid.

If you are interested in learning more, you can contact me at Amanda@gordonfamilylaw.com for more information.

What if the property that I want to transfer to my spouse produces income?

If you have property such as accounts receivable, deferred compensation, pension plans, these types of property may have an “income” component.  The common recommendation is to reserve disposition of these assets until you know the details about the property and then to divide the property between the parties such that each spouse reports his or her share of the income when received. You can structure this as contingent spousal support or an allocation of community income which is similar to the division of stock options.

If you are interested in learning more, you can contact me at Amanda@gordonfamilylaw.com for more information.

The information set forth in this Question and Answer was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding United States federal tax penalties that may be imposed on the taxpayer.  The information was written to support the promotion or marketing of the matters addressed in this Question and Answer.  All taxpayers should seek advice based upon the taxpayer’s particular circumstances from an independent tax advisor.  The foregoing language is intended to satisfy the requirements under the regulations in Section 10.35 of Circular 230.

Will I be taxed on when I transfer property to my spouse in a divorce?

Experienced Bay Area family law attorneys will advise clients about the tax consequences in a divorce.

Section § 1041 of the Internal Revenue Code says that if you transfer property from one spouse to another during marriage or incident to divorce, then there is no recognition of tax gain or loss.

This is true regardless of where the property is located. The no tax transfer rule includes any property, real or personal, tangible or intangible can be transferred tax free, including an promissory note, life insurance, pension buyout payment.

There is no limit on the amount or type of property that spouses can transfer to each other without incurring tax.

The IRS allows for non-recognition of gain/loss between spouses and ex-spouses up to one year after the date of termination of marital status and transfers within six years of the divorce may qualify if the transfers are “incident to the divorce”.

The transfer must be to or “on behalf of” a spouse or former spouse. A transfer to a third party on behalf of a spouse qualifies for §1041 treatment if the transferee spouse requests or ratifies the transfer in writing. The writing must state that the parties intend §1041 to apply and the transferor must receive the document before filing his or her first tax return for the year of the transfer. Approved writings include (1) a divorce or separation instrument, (2) the transferee’s written request and (3) the transferee’s written consent or ratification which includes a reference that the transfer is intended to qualify for non-tax treatment under IRC §1041.  A transfer will be “on behalf of” the other party if it satisfies an obligation of the transferee spouse.  

Transfers More Than One Year After Judgment of Marital Termination. Transfers more than one year after termination of marital status will qualify for §1041 if they are “related to the cessation” of the marriage.  If the transfer occurs within six years after the date on which the judgment dissolving the marriage was entered, the transfer is presumed to be “related to the cessation of the marriage”. If the transfer is more than six years after the termination of the marriage, it is presumed not to be related to the cessation of the marriage.

If you are concerned about timing problems you can solve them by creating a specific reference in your marital settlement agreement where you cite IRC §1041.  The six-year presumption of “related to the cessation of the marriage” is different from a “transfer within one year of the marriage termination” which is mandatory and not a presumption.  A transfer within the first year will be subject to §1041 rules no matter what business or other reasons are present.

The six-year presumption is rebuttable. For example, if there is a transfer three years after the marriage ends but it can be established that it was required for business reasons, the transfer may not be considered as one related to the cessation of the marriage.

After six years from the date of dissolution, the presumption that it is not related to the cessation of marriage may also be rebutted if it can be proven that it was to affect the division of marital property. While most transfers occur within 6 years, it is possible that the transfer may take longer due to extended litigation or delayed sale of property if there are minor children.

The information set forth in this Question and Answer is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding United States federal tax penalties that may be imposed on the taxpayer.  The information was written to support the promotion or marketing of the matters addressed in this Question and Answer.  All taxpayers should seek advice based upon the taxpayer’s particular circumstances from an independent tax advisor.  The foregoing language is intended to satisfy the requirements under the regulations in Section 10.35 of Circular 230.