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US Tax: Property Transfers At Divorce And The Foreign (Non-US) Spouse

House and lawAs if divorce were not a stressful enough time, the complexities of the US tax rules when a non-US spouse is involved just make it all the more unbearable.

Here are the US Tax basics to keep in mind with respect to property transfers. (Payments of alimony will be the subject of another tax blog posting).

You May Have Both Income Tax and Gift Tax Issues

Under the general US tax rules, asset transfers between spouses incident to a divorce are tax-free under Code Section 1041. There is no realization of a gain or loss by the transferor-spouse upon such a transfer of property. Instead, the transfer is treated as a “gift”. If the spouses are both US citizens, the case is straightforward and simple – no US Income tax or Gift tax consequences will result. Not so simple if one spouse is a non-US citizen and even more complex if the non-citizen spouse is also a “nonresident” alien (NRA).

A transfer is treated as incident to a divorce if it takes place within a year of the divorce or is “related to the cessation of the marriage”. Generally, a transfer is related to the cessation of the marriage if it is pursuant to a divorce or separation agreement and occurs not more than 6 years after the date on which the marriage ceases.

Very significantly, in order for the income tax-free treatment of Code Section 1041 to apply, the recipient of the property cannot be a “nonresident alien” (NRA). For example, if you transfer appreciated stock to your NRA spouse as part of the divorce settlement, you will have to pay tax on the inherent gain in the stock, generally just as if you sold it. In addition you may have Gift Tax consequences. Read more