Generally, no gain or loss is recognized on a transfer of property from an individual to a spouse or former spouse if the transfer is incident to a divorce. Non-recognition applies even where the parties are acting at arm’s length and the transferee spouse pays full consideration for the property.
Tax Tip – In deciding how to divide their assets, the parties should consider allocating assets with greater potential gains to the spouse in the lower tax bracket and allocating assets that have appreciated little or have declined in value to the spouse in the higher tax bracket.
For retirement accounts, a spouse or former spouse of an employee may receive a tax-free rollover distribution from that employer’s qualified retirement plan as part of a court-approved property settlement.
The Marital Home:
The non-recognition rule applies to a spouse’s transfer of the martial home incident to divorce. If the home is later sold to a third party, gain up to $250,000 can be excluded from gross income, provided the spouse has owned and used the home as his or her principal residence for periods aggregating two of the five years immediately prior to the sale.
Tax Tip – With proper planning, the divorcing couple can shield up to $500,000 in gain from the sale of their principal residence where (though living apart) one spouse’s continued use of the residence is a condition of the divorce agreement.
The tax savings in a proposed settlement which obligates one party to pay debt and taxes on the former marital home (providing for significant tax deductions to the paying spouse) should be used as leverage in negotiations.