Dividing up assets when a marriage ends: Tax implications.

AuthorSarenski, Theodore J.

An often-cited belief is that 50% of marriages now end in divorce. Regardless of whether this statistic is accurate (for first marriages, the divorce rate more likely peaked at around 40% in the United States around 1980 and declined to about 30% by the early 21st century), most CPAs have observed the impact that divorce can have in the lives of friends and clients (or in their own lives). A tax practitioner can greatly help people in divorce by reducing the overall stress of the divorce process and providing the clarity they need to make good financial decisions for their future.

When dividing assets in divorce, the tax considerations can be straightforward in simple situations but can become complex very quickly when the assets are larger and more diverse. This column focuses on the tax implications of dividing marital property.

Beginning with the basics, Sec. 1041 provides that no gain or loss is recognized on the transfer of property between spouses. This Code section, which was introduced in the Deficit Reduction Act of 1984, P.L. 98-369, changed the treatment of transfers between spouses, which previously were treated like sales (referred to as the Davis rule, after Davis, 370 U.S. 65 (1962)).

Transfers that qualify under Sec. 1041 do not have to recognize gain or loss for income tax purposes, and the transferee spouse receives carryover basis like a gift. Sec. 1041's nonrecognition rule applies to transfers between married partners who are not contemplating divorce and, in addition, extends to transfers that are incident to divorce. "Incident to divorce" is defined in Sec. 1041(c) as a transfer that occurs within one year after the date on which the marriage ceases or that is related to the cessation of the marriage. Temp. Regs. Sec. 1.1041-1T further defines the term "related to cessation of the marriage" to be a transfer pursuant to a divorce or separation instrument, if the transfer occurs within six years after the date on which the marriage ceases. (Caution: Sec. 1041's nonrecognition rule does not apply to transfers made to nonresident alien spouses or to transfers in trust where liability exceeds basis--Secs. 1041(d) and (e)).

Considering Sec. 1041's nonrecognition rule as well as the unlimited marital deduction for federal estate and gift tax purposes allowed under Sec. 2523 for gifts of cash and property to a spouse, most property transfers in divorce will likely be nontaxable transfers.

With the presumption that any transfer within six years from the date of divorce...

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