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Mark Abzug

Capital gains tax and property transfers in divorce

On Behalf of | Nov 10, 2023 | Property Division

If you and your soon-to-be ex will be dividing up substantial assets you’ve accumulated over many years as you divorce, you may have some concerns about the tax implications. Certainly, that’s a factor you should consider so that you know whether something is worthwhile in the long run to seek or whether it’s better to let it go and ask for something else. It’s often wise to rely on the advice of tax and financial professionals in addition, of course, to experienced legal guidance. 

Many people are concerned about whether they’ll have to pay capital gains tax on assets that they receive or give up in the divorce from their spouse. Fortunately, the IRS recognizes that many assets change ownership during divorce. It doesn’t require reporting of capital gains (or losses) if the transfer of ownership is “incident to a divorce.” 

Note that this applies only to transfers of property – not to property you sell in the divorce. For example, if you sell the home that has been your primary residence, it could be subject to capital gains tax. However, if you file your taxes one last time as a married couple, you can exclude up to $500,000 in capital gains on it.

Just what does “incident to a divorce” mean?

 There are timelines you need to be aware of. For example, it’s assumed that any assets transferred between divorcing spouses within a year after the divorce is final are part of the property division agreement or a more informal agreement. No capital gains need to be reported, and you don’t have to provide any documentation proving that the transfer was part of the divorce to the IRS.

 If a transfer isn’t finalized within that first year, it can still be considered incident to the divorce for tax purposes up to six years following the signed divorce decree. However, the transfer must be codified either in the original divorce agreement or a later court-approved modification to the agreement.  

If you’re planning to turn around and sell an asset you received in the divorce, you may need to deal with capital gains tax when you do that. That’s something else you’ll want to consider. When negotiating your property division agreement, it’s important to understand not just the immediate value of an asset, but the long-term costs or potential for growth as well. This can help you make smarter decisions.