Not Knowing Cost Basis Of Property At Divorce Can Be Expensive

Q: When my husband and I got divorced last year, our assets totaled $500,000. I got the house ($100,000) and the mortgage, and he kept his pension and the cash ($250,000). Because I had not worked outside the home for years and needed income, everyone suggested that I take the remaining $150,000 in real estate limited partnerships that were paying 15% per year ($22,500). Since then, I have not been able to get a job and have been forced to sell some of my assets . I didn't want to sell the house, but found the limited partnerships very difficult to unload. Finally, I sold two of them for half of what they were said to be worth when we divorced. Now I have to pay a "recapture tax" because my husband and I had taken deductions in prior years. I am going downhill fast. Why did I ever get in this shape and how do I get out?

A: You're not alone. It's not unusual for a person with little business experience to get into trouble. Many folks purchase real estate limited partnerships to get income tax deductions. There are several basic problems with limited partnerships and they get worse at the time of divorce: (1) The value is not readily ascertainable. You may have paid $25,000 for a limited partnership interest, but no one really knows what it's worth today; (2) Generally, there is not a ready market for the sale of limited partnership interest; and (3) Each tax deduction taken reduces the basis of limited partnership interest.

For example, if you and your husband paid $25,000 for a limited partnership and took $15,000 in tax deductions, the remaining basis in the limited partnership is $10,000. When the partnership interests were transferred to you at divorce, you took them with what is called a carry-over basis -- the same basis as they would have had if you and your husband had stayed married. When you sold your limited partnership interest for $15,000, which is $5,000 more than the tax basis, you have a gain of $5,000, so you must pay the taxes on that amount just as if you had earned it. This is the "recapture" you talked about.

It sounds like your lawyer failed to tell you all this before you agreed to take these assets. If your lawyer didn't understand all the ramifications, he or she should have called in an expert to value these assets and tell you about the income tax recapture consequences if you sold these partnership interests. We know this isn't much consolation now, but it sounds as though you have the basis to discuss with your lawyer the best way for you to be reimbursed.

Q: My husband and I were divorced nearly ten years ago. Recently, when he reached age 62, he took early retirement and informed me that he could no longer pay the alimony to which he agreed and which the court ordered. Can he get away with this?

A: Maybe and maybe not. Factors that are sometimes considered by the courts include his age, health, and reasons behind the retirement; the timing of the retirement; how long the retirement was planned and how much notice was given; his ability to pay alimony after retirement; your ability to support yourself; and the expectations of both of you at the time of the divorce.

Since early retirement is becoming increasingly common, it might be wise for our readers who are going through divorce to try to include a clause in the settlement that specifies the intent of both parties relative to what will happen on early retirement. A simple provision like this might have saved you this problem and given predictability to your life.