Tax Brake with Robert G. Nath, Esq.

Such a transfer is treated as a gift for income tax purposes. That means it's not taxed, and the donee uses the donor's tax “basis” that existed immediately before the transfer. That rule applies to gains, and losses as well. So, for example, if you transfer 1000 shares of Nostart Dot Com, Inc., which cost you $5,000 and is now worth $50, there is a loss built in of $4500. The transferor does not get to use this loss; the transferee does. This is an exception to the normal rule that says the donor cannot transfer deductible losses. (An exception applies in the case of “passive activity” losses. There are other exceptions, so consult your tax advisor before making any such transfers.)

In a private ruling in 1996, the IRS applied this principle to a sole proprietorship situation. The husband transferred half of his sole proprietorship business, and half of a partnership interest, to his wife in a divorce. The debts exceeded the husband's tax basis. The IRS said the husband could not take the loss.

So if there are losses in stocks that have not yet been taken by a couple who are divorcing, those losses are a valuable tax asset in the discussions, in effect a discount courtesy of Uncle Same. It's built into the asset. If Spouse A sells the stock before transfer, Spouse B does not get the loss, and Spouse A can use it on his or her tax return. If the couple files separately, that's a problem for Spouse B. (If they file jointly, then the joint return can reflect the loss.) But if Spouse A transfers the stocks to Spouse B incident to the divorce, Spouse B gets the benefit of these losses.

Careful planning for gains and losses, short and long term, should accompany consideration of stock transfers in a divorce.