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Property division and possible tax consequences

While no taxable gain or loss in theory is recognized when there is transference of property incidental to a divorce, taxable consequences can nevertheless come about when disposal of property takes place.

What is called the tax basis needs to be taken into account when property is sold. For example, when someone purchases a home the tax basis is often the cost. If the home is sold for more than the purchase price there may be income generated that will have to be reported to the IRS. In the most basic case the formula would be: Purchase Price - Tax Basis (Sales Price) = Taxable Gain.

Nothing is that simple, however, when it comes either to taxes or divorce. During a divorce negotiations are often conducted between each party as to possession of the home. In those circumstances one party may pay money to the other party to buy out their interest.

Here's where it becomes complicated. Let's say that a California couple many years ago buys a home for $30,000. The house increases in value over time. At the time of the divorce, one spouse agrees to buy out the other spouse's interest for $150,000. However, since this is incident to a divorce the $150,000 payment does not increase the tax basis to reduce the amount of taxable gain. If the house is later sold by the spouse in possession of the home for $300,000, that spouse now has a taxable gain of $270,000.

As one woman learned, the same applies to transference of retirement accounts as part of a divorce. She claimed her husband transferred a 401(k) to her to make up for debt owed. She did not roll the 401(k) over and instead withdrew funds from the account. The husband had only contributed pre-tax dollars to this account so that the tax basis was zero. As it was part of a divorce settlement, it didn't matter whether the husband was in debt to her. In other words, the woman had to pay taxes on the money that was withdrawn and she also was stuck paying tax penalties.

Speak to an experienced property division attorney to make certain such consequences do not arise. We want to have any asset division performed correctly so no unpleasant surprises occur down the road.

Source: Forbes, "Non-recognition On Divorce Transfers Hurts Receiving Spouse," Peter J. Reilly, May 7, 2014

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Victoria S. Linder Law Office
5303 Folsom Boulevard
Sacramento, CA 95819

Phone: 916-905-4805
Fax: 916-498-0127
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