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Capital gains tax and asset transfers during divorce

On Behalf of | Mar 7, 2023 | Asset Division |

During divorces involving significant and complex assets, spouses often transfer them between one another to achieve a fair property division agreement – and to walk away with the assets they most want. For example, maybe your soon-to-be-ex has agreed to give you the home on Cape Cod which is titled in their name, while you’re giving them a share of your stock portfolio. These are just two fairly simple examples.

One significant concern of many divorcing couples involves whether they’ll have to pay capital gains tax on property that’s transferred to them in a divorce settlement if it’s increased significantly in value over the years. Real estate property and land are two assets that can increase by many hundreds of thousands, if not millions, of dollars over time. Do you need to factor the capital gains tax into your divorce settlement to be sure it’s wise to take on this property?

The good news is that the IRS is aware that divorcing couples often do a fair amount of asset transfers during and following a divorce. Therefore. it doesn’t consider capital gains or losses on these assets. They’re considered “incident to the divorce” or Section 1041 transfers (named after the internal revenue code that addresses them).

When can couples make penalty-free transfers?

Any asset transfers between ex-spouses that are finalized by the end of the first year after the divorce decree is signed are automatically considered Section 1041 transfers. The IRS doesn’t require any documentation, like a copy of the property division agreement, to prove that they’re divorce-related.

Some transfers can take longer to finalize, such as a share of a business or some real estate transfers. For any transfer that’s finalized more than 12 months after the divorce but within six years, the person who is the recipient of the asset needs to be able to show that the transfer is either addressed in the divorce documents or modifications made to them and agreed to by the court.

Your professional team can provide guidance to you as you determine what assets you want to seek and accept. It’s always crucial to look at the long-term as well as short-term implications of your decisions.