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>|
|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: