1. Taking Basis into Consideration When Dividing Property
Even though IRC Section 1041 generally allows for the tax-free transfer of property between spouses in a divorce, the basis of such property relative to its current (or projected) Fair Market Value is critical in determining an equitable division of the marital estate.
Example: Fred and Ethel are engaged in divorce proceedings. The primary asset in the marital estate is a rental apartment building that they have owned for thirty years as community property. The basis of the property is $200,000 and the fair market value of the building has been appraised at $800,000.
| Sales Price of Land | $800,000 |
| Less Fred’s Original Basis | <$100,000> |
| Less Fred’s Additional Basis Transferred from Lucy | <$100,000> |
| Net Gain | $600,000 |
| Tax on Gain (assuming a combined Federal and State rate of 30%) | $180,000 |
| Fred’s Net After Tax Gain | $420,000 |
Assume that it is agreed that Fred is to buy out Ethel’s 50% interest in the building for $400,000. Such a transaction would be covered under the general provisions of IRC Section 1041 and would be tax-free to Ethel, with Fred assuming Ethel’s share of the building’s carryover basis. Were Fred to sell the building he would likely have the following economic and tax consequences:
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