Tax Aspects Of Dividing Property In A Divorce (Series – Part 2)

This valuable series on Dividing Property In A Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA. 

  1. Major Exceptions to Nonrecognition of Gain or Loss
    1. Transfers to trust in which property’s liabilities exceed basis.[1]
      1. Gain is recognized by transferor.
      2. Gain equals the amount by which property’s liabilities exceed basis.
      3. Trust increases its’ basis in the transferred property by the amount of gain
    2. Transfer to Trust of Installment Instrument
      1. Transferring spouse recognizes untaxed built in gain upon transfer.[2]
      2. Trust takes carryover basis plus trust gets increase in basis by the amount of gain recognized by transferee.[3]
      3. Post transfer interest income paid on installment instrument is taxable to trust.[4]
      4. Example: Transfers to Trust in Which Liabilities Exceed Basis.

Ward and June are in the process of getting a divorce. Ward inherited as separate property, a Japanese Samurai Sword that his grandfather brought back from World War I as a war trophy. The sword has an estimated Fair Market Value of $750,000.

Ward’s basis in the sword is $100,000, and he has pledged it as security for a business loan in the amount of $500,000.  As part of the divorce settlement, Ward transfers the sword to a trust for the benefit of June. The trust assumes the loan on the sword. Ward must recognize a gain of $400,000 on transfer calculated as follows:

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