Q: This isn’t a question, but a comment on a recent column about buying out an ex-spouse.
When one spouse purchases the other spouse’s interest in property, the ‘seller’ is deemed to have received a gift and the ‘buyer’ cannot increase the tax basis in the property, according to IRC Section 1041.
This tax issue is seldom addressed in answers to questions from divorcing couples, but I believe that this should be part of every answer to questions about buying out an ex-spouse.
One of my friends purchased his ex-spouse’s equity in their home and in two pieces of rental property. He gave her a tax-free cashier’s check for $400,000. He received no increased basis for the rentals and had a taxable gain on the sale of the residence several years after the transactions.
A: Thank you for your letter. According to my research, IRC Section 1041 provides that no gains or losses are recognized on property transfers between spouses during marriage, or on property transfers between ex-spouses, as long as that transfer is part of the divorce agreement.
It would be as if one spouse gave his or her interest in the property to the other. The transferee-spouse takes on the transferor’s cost basis, which is how future profits will be calculated.
According to the IRS, the basis of the property transferred between former spouses is not increased even if there is a cash payment as part of the transfer. This has been confirmed in Tax Court.
If your friend was upset at giving his spouse $400,000 and later sold the property only to have to pay more taxes than he thought he would, he should have negotiated a different payment arrangement with his now ex-spouse.
When accounting for the value of the property at the time of the split, the parties should have considered what each of them would pay in taxes if both of them had sold the property. If they had taken into consideration what each of them would have received after the payment of real estate commissions, other transaction costs and federal and state income taxes, the split might have been quite different.
If the spouse who kept the property then sold the property, that spouse effectively then has to pay federal and state income taxes on the other spouse’s share.
And I agree, this is an important concept that many divorcing spouses with real property should consider. If you or someone else you know is in this situation, a detailed conversation with an accountant who handles the tax consequences of plenty of investment property transactions is in order.
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