Insight: Basis of Property Transferred Between Spouses Incident to a Divorce

Posted by Lee Reams Sr., BSME, EA on

When one spouse transfers property to another spouse the basis of the recipient spouse is the same as the transferor-spouse's adjusted basis in the property (Code Sec. 1041(b)).  

This rule applies even where the transaction is a sale between the spouses or where the transferee-spouse pays the transferor-spouse (as required under the divorce settlement) for the transfer of title to the property to the transferee-spouse (Reg § 1.1041-1T(a), Q&A-2).

This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than its fair market value at the time of transfer and applies for purposes of determining loss as well as gain, upon later sale by the transferee (Reg § 1.1041-1T(d)). There are exceptions that may apply to certain transfers in trust (Sec 1041(e)) and transfers of installment obligations into a trust (Sec 453B(g)). 

Example: George owns land in which his basis is $10,000. He sells it to his wife Allison for $18,000, its fair market value. George does not report any gain on the sale. Allison is the new owner, but her basis is $10,000 (George's basis), even though she actually paid $18,000 for it.

There are other pertinent issues related to transfer of property between spouses that may be of interest. 

Sale After Ex-Spouse Retains Property for Some Period of Time – In some instances in a divorce settlement both spouses will continue to own the “family” home and one will be granted the use of the property. This generally occurs when there are minor children and the custodial parent is granted use of the property until such time as the children reach the age of majority. 

For purposes of this discussion we shall identify the spouse or ex-spouse that was granted use of the property as the in-spouse and the other one as the out-spouse. Sec121 includes a special provision where the out-spouse’s use of the home mirrors the in-spouse’s use period, and since they both own the property, both the in-spouse and the out-spouse can benefit from the Sec 121 home gain exclusion when the home is sold. The only time the out-spouse would not qualify is if the out-spouse had taken the Sec 121 exclusion on another home in the two years prior to the sale of the family home, and thus would not qualify because of the one exclusion every 2 years limit. (Reg. §1.121-4(b)(2))  

Spousal Buy-Out Debt - In divorce situations, debt secured by the home to buy out a former spouse’s interest in a home is acquisition debt. This rule is applied without regard to Code Section 1041, which treats certain transfers of property between spouses incident to divorce as nontaxable events. (Notice 88-74, 1988-2 CB 385)

Transfers and Passive Loss Carryovers - If a taxpayer transfers property to a spouse incident to a divorce, the exchange is treated as though it were a gift. Therefore, any suspended losses attributable to the spouse giving up the interest in the passive activity are added to the basis of the property transferred to the other spouse. For the receiving spouse, the basis will be increased by the ex-spouse’s suspended losses, but the receiving spouse’s suspended losses on the same property will still be considered suspended losses, which are available currently to offset passive income. (Sec 1041(b) and Sec 469(j)(6))

Section 121 Home Gain Exclusion – One huge issue that is frequently overlooked is when one of the spouses is awarded sole ownership of the couple’s home as part of the property settlement. When that occurs, that spouse assumes the community basis, and as such is responsible for the tax on any gain not excludable under Sec 121. But keep in mind the exclusion just dropped from $500K to $250K.  

 

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