The tax code section 1041 says transfers of most assets between spouses are tax free if made incident to a divorce. Special rules apply to retirement accounts and IRAs.
Transfers “incident to divorce” need to be done within one year after the date the marriage ends or within six years after that date as long as they are made in accordance with your divorce agreement.
When an asset is transferred, the ex-spouse who receives the asset takes over its existing tax basis (for determining gain or loss purposes) and the existing holding period (to determine if the sale will be classified as short term or long term).
The ex-spouse who ends up owning an asset that has appreciated (value is more than cost or tax basis) must recognize taxable gain when it is sold, unless some tax law exception applies (like sale of a principal personal residence).
A qualified retirement plan such as a profit-sharing plan, 401(k) plan or a defined benefit pension plan has special rules. A transfer of an interest in those retirement plans should only be done by a “qualified domestic relations order” (QDRO). That is important to avoid bad surprises.
But a QDRO is not required when you are required to turn over some of your traditional IRA, Roth IRA, Savings Incentive Match Plan for Employees IRAs and Simplified Employee Pension amounts. But you can do a tax free transfer of all or part of those items to your ex only if the transfer is ordered by a divorce or separation agreement as a “decree of divorce or separate maintenance or a written instrument incident to such decree.”
If you transfer money from your IRA to the other party, either before or after the divorce, it will be a taxable distribution to you unless you are required to make the transfer by a divorce decree or separation instrument. Don’t transfer IRA money to the other party until you are so required.
Divorces in 2019 and prior divorce agreements that are substantially revised have special rules on alimony. Alimony paid is NOT a tax deduction and alimony payments received are not income. That is different than prior years’ tax law. So, it is important to look at each asset and see what potential tax liability is involved. For example, an IRA has a tax liability, distributions will be taxed. Cash does not have a tax liability. If your business is incorporated, consider arranging for a stock redemption to buy your ex-spouse’s shares. The valuation of that corporation is very important and should be done by a qualified business valuation expert.
Work with your attorney and CPA to avoid surprises when a divorce is involved.
Did you hear? “Life is short. Eat dessert first,” by Jacques Torres.
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.