When an asset owned by a spouse is transferred as a
result of divorce, there are no immediate tax consequences to either spouse. The
one transferring title to the other spouse does not recognize any gain, even if
the home may have appreciated in value since it was purchased. LIkewise,
the spouse receiving the home does not recognize any income either. However,
the spouse who obtains title to the home steps into the shoes of the other
person when it comes to basis (generally the amount of your
investment in a property for tax purposes). In effect, the spouse
who winds up with the home also winds up with a potential tax bill. When the
spouse that has received title to the house later sells the house, the gain on
the sale (prior to exclusions) will be calculated using the original basis of
the house, not including any payments that you made to your spouse as part of
obtaining title. That can mean a hefty tax bill for you.
For example, Mary and John Smith buy a farm during their marriage for $600,000.
At the time of divorce, the fair market value of the house is $800,000. Mary
pays John $200,000 to obtain sole ownership of the property. Years later, she
sells the property for $950,000. She has assumed that she will owe taxes
(subject to other tax exclusions) on $150K ($950K less $600K original basis less
$200K that she paid to John). Wrong! The $200K that she paid to John is not
included in the tax basis of the property so she will owe taxes on $350K.
The "payment" does not just include money that you pay
to your spouse. If you agree to receive the farm in the settlement and in
exchange your spouse will be allowed to maintain ownership of $200K in a joint
bank account, that would treated by the IRS as a payment by you to your
spouse. And there are other similar situations that would be treated as a
payment by you subsequent to a divorce that would not be included in the basis
of the property for purposes of calculating a gain.
What does that
mean to you? Your tax professional or attorney needs to make an educated guess
at what your future tax liability would be on any payments you make to your
spouse in the settlement and include that in the negotiations.
How you plan
now can make a big difference to your wallet down the road.