Tax Brake with Robert G. Nath, Esq.

“I am recently divorced. My husband continues to live in our house (he owned it before we married) I received a lump sum of 30g for the house equity I was entitled to. Is this taxable income to me? Do I have to claim it all at once?”

The answer is that neither the transfer of cash to the wife nor the transfer of her interest in the house to her husband is taxable. That's the good news. The bad news is that taxes come later.

The tax law (Section 1041 of the Internal Revenue Code) provides the general rule that “no gain or loss” is recognized when spouses transfer property “incident to a divorce.” The transfers are treated as gifts. So in the example above, it's as if husband made a gift of $30,000 to wife, and wife made a gift of her interest in the house to husband. The wife pays no tax, ever, on that gift (it's cash). The husband, however, may pay tax when he sells the house. That's because the tax “basis” of the wife's interest in the house carries over to the period of his ownership. For example, if the house cost $160,000, the wife's basis would be $80,000. That carries over. So when husband eventually sells the house, there could be a gain.

The “no current tax” rule described above applies to all transfers of “property” between spouses incident to divorce, and is mandatory. The couple has no option to treat the transfers as a sale. The rule applies to losses as well, with some exceptions. So if husband transfers loss property to wife, and then she sells it, in general she can take the loss. (But there are some tricky rules here; check with your advisor.)

The tax regulations require that the transferor provide to the transferee sufficient records to allow the transferee to determine the tax basis and holding period of the property transferred. Often this is a problem in a divorce, but since the regulations require it, you have one additional argument for insisting on property and complete documentation.