Dividing property and other assets during divorce can be a highly emotional process. However, it’s crucial to be smart about it. That means looking at the long-term financial and tax impacts of keeping an asset, letting your spouse have it or agreeing to sell it and adding the proceeds to the marital estate for division. The complexity of the process is why many divorcing spouses consult with their own financial and tax professionals in addition, of course, to seeking experienced legal representation.
One concern that many people have is whether they’ll have to pay capital gains tax on property that their spouse signs over to them or that they transfer to their spouse. The good news is that it’s relatively easy to avoid capital gains taxes during divorce.
“Incident to the divorce”
The IRS recognizes that it’s common for separately or jointly owned property to change ownership during divorce. That’s why it doesn’t require people to report capital gains or losses on property that’s transferred “incident to the divorce.” To make things even easier, any assets that are transferred between divorcing spouses are assumed to be incident to the divorce up to a year after the divorce decree is signed.
Any transfers not finalized within a year are still exempt from capital gains tax. However, the transfer must be listed in the divorce agreement or a modification approved by the court. That’s the rule up to six years following the divorce.
What about assets you sell to someone else?
With all this said, if you’re planning to sell an asset transferred to you relatively soon after the divorce, you may need to pay capital gains tax when you do that. Therefore, it’s worth considering that concern as you decide what assets to pursue during the property division process. For example, you’ll likely incur less in capital gains liability on assets that were purchased relatively recently.
Further, if you and your spouse decide to sell an asset and split the proceeds, the capital gains exemption doesn’t apply. Remember, though, that if you sell your primary residence, any profits on that are exempt up to $500,000 if you file your final taxes as a married couple (up to $250,000 if you file separately).
It’s a lot to consider at a difficult time in your life, and this is just a brief overview of the issue. That’s one of the many reasons why seeking sound, experienced legal guidance is critical to making smart decisions prior to and during the property division process.