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Transfers of Property Between Spouses

Transfers of Property Between Spouses

Transfers of Property Between Spouses

An important provision of the Internal Revenue Code related to divorce is Code Section 1041. It provides that no gain or loss is recognized as taxable income for transfers of property from an individual to a spouse or former spouse if the transfer is incident to a divorce. The transfer is treated as a gift and therefore the tax basis that the transferor spouse had in the property is carried over to the recipient spouse. The transfer is tax-free. The transferee spouse becomes responsible for all of the taxes which are generated upon a future sale of the property.

Transfers of property incident to divorce are defined as transfers occurring within one year after the date on which the marriage ceased or transfers that are related to the cessation of marriage. In order to qualify for favorable Section 1041 treatment, transfers related to the cessation of marriage must be made pursuant to a divorce instrument and must occur within six years of the date of divorce.

If the transfer takes place more than six years after the divorce and the taxpayer can show that efforts were being made to effect the transfer of the property as soon as possible, then the transfer can still qualify under the favorable tax treatment of Code Section 1041.

IRS Ruling on Residence Transfer

The IRS issued an interesting ruling in Private Letter Ruling 9306015 dated November 13, 1992, regarding transfers between spouses. The facts of the case are that the wife (W) is permitted to stay in the house until the youngest child finishes high school or reaches age 18, or until W remarries, cohabitates or until she moves from the house. She has the right to sell the house sooner if she chooses. At the time of the sale, W receives the first $1,000 and the balance of the proceeds are split equally. W and husband (H) each own a one-half interest in the house. The original divorce decree does not require H to transfer or sell his interest in the house to W nor is he precluded from transferring his interest to W at any time.

The couple agreed under a consent order dated eight years after the divorce that the H will transfer all of his interest in the house to W for cash and in return W will discharge of all of H’s mortgage and other marriage-related obligations.

The facts indicated there was nothing included in the original divorce agreement remotely suggesting that H would transfer his interest to W. The agreement clearly states that the property would be sold to a third party. The only indication of a sale between H & W occurred in the consent order more than eight years after divorce. The husband could have sold his interest to W at any time after the divorce. No facts were presented which show that additional time past the six year cut-off was necessary to effect the transfer. Furthermore, there was no legal or business impediment to the earlier transfer of H’s interest in the house to W. Under the divorce instrument, H could have transferred his interest to W at any time.

Based on the above, the IRS ruled that the sale from H to W was not a transfer to effect the division of marital property, but an arm’s length transaction between two parties who happen to be former spouses. Accordingly, the transfer is not covered by Code Section 1041 and does not benefit from the favorable tax treatment therein. W’s basis in H’s one-half interest in the house is equal to the cash and the fair market value of other property transferred by W under the consent decree.

The ruling, which was requested by W, did not address the tax consequences to H. Since Section 1041 did not apply, we can presume that H would have a taxable transaction. His sales price would presumably be the total of the cash he received, his half of the mortgage assumed by W and the fair market value of any other property transferred by W under the consent decree. His basis would be his previous tax basis. Since the house was not his principal residence at the time of the sale to W, H would not be entitled to rollover any gain into a new residence. He would be required to pay tax on his gain which would be the difference between the sales price and his basis.

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