Property Sale to Satisfy Debt to Ex-Spouse Was Not Incident to Divorce.

• Author: INGHAM, MARSHA HATCH

T and H had been married since 1974. In 1975, they bought four parcels of land, two adjacent to a lake and two adjacent to a roadway. They lived in a house on one of the lakefront lots.

In 1991, T and H were divorced. As part of the property settlement, T received the lakefront lots and the house; H received the roadside lots. T was also required to pay H an amount that represented the value of his interests in the lakefront properties. The "Decree of Dissolution of Marriage" provided that T's interests in the family residence would be paid by T immediately on the sale or exchange of the residence, but no later than five years. Shortly after the divorce, T and H sold all four lots to the same buyer.

Ultimately, T filed a refund claim for taxes paid on her share of the sales proceeds, arguing that the sale qualified for nonrecognition treatment as a transfer incident to a divorce under Sec. 1041(a)(2). The IRS and the district court denied this claim. The Court of Appeals (opinion Graber, J.) affirms.

T contends that she was not required to pay income tax on any capital gain arising from the sale of the two lakefront properties, because that transaction qualified for nonrecognition as a transfer of property to a former spouse "incident to...divorce" under Sec. 1041(a)(2). T argues that, although she transferred the lakefront properties to a third party and not to H; her former spouse, the sale should be treated as a constructive transfer to a former spouse, because she sold the properties to satisfy her financial obligation to H under the divorce decree. In other words, T asserts that, for tax purposes, the transaction should not be treated as a direct sale from T to the third-party buyer, but rather as a constructive transfer first to H and then a direct sale by H to the third party. H then would be liable for any tax arising from the sale.

T bases her argument on Temp. Kegs. Sec. 1.1041-1T, which provides that, in certain circumstances, "transfers of property to third parties on behalf of a...former spouse" qualify for nonrecognition as a transfer incident to divorce. Such a transfer of property will be treated as made directly to the nontransferring spouse (or former spouse) and the nontransferring spouse will be treated as immediately transferring the property to the third party. The deemed transfer from...