Dividing Property In Divorce Tax Traps – Part 13

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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