During a divorce settlement, spouses must decide how to divide their property and assets. Knowing your tax liability regarding your divorce settlement proceedings can help you minimize loss and have a solid financial footing.
Learn if you pay capital gains tax on assets you sell or acquire during a divorce. You can also learn exclusions you can claim during your settlement to minimize liability.
Tax Impact of Transferring Property
In most cases, spouses do not have to pay capital gains taxes on property transferred during a divorce settlement. Section 1041(a) of the U.S. tax code states that the IRS will not recognize gains or losses on property transferred from one individual to a spouse.
This rule also applies to former spouses, as long as the property transfer is considered an "incident to divorce."
A property transfer is considered an incident of divorce if:
- The transfer occurs within a year after the marriage end date, or
- The transfer is related to a divorce
The IRS treats the transfer as a non-taxable gift if a property transfer falls under this category. The rule does not apply to spouses who are considered nonresident aliens.
The IRS considers property transferred six or more years after the divorce as unrelated to the settlement. However, it may classify a delayed transfer as incident to divorce under certain circumstances; for example, there was a dispute about the property’s value.
Tax Impact of Selling a Property
If you and your spouse choose to sell a property, such as your primary residence or an investment property in your divorce proceedings, you must pay capital gains tax if you make a profit (capital gain) from the sale.
If you sell your principal residence, you and your spouse can exclude the first $250,000 gain from your taxable income. Your primary residence is the home you have lived in for at least two of the five years before you sell.
For a primary residence, you only have to pay capital gains tax if you earn over $250,000 (or $500,000 if you and your ex-spouse file jointly in the same year) on the sale.
If you or your spouse serve in the military, the Foreign Service, or the Intelligence Service, the IRS may extend the five-year window to ten years. The IRS may reduce the exclusion if you’ve owned the house for less than two years.
If you buy your primary residence from your spouse and later sell to a third party, you must pay capital gains tax on the sale. However, you may use tax minimization strategies, like a 1031 exchange, to defer capital gains and invest in a like-kind property.
Additional Capital Gains in a Divorce Settlement
Aside from real estate, capital gains tax may apply to other assets you acquire or sell during a divorce. These include valuable collections such as jewelry, stamps, coins, stocks, and bonds. While the standard capital gains tax rate for most people is between 15% and 20%, state capital gains rates may also apply.
Additionally, federal capital gains are taxed at 28% for 1202 qualified small business stocks. They are taxed at 25% maximum for section 1250 real property, and 28% for art or collectibles. If your divorce settlement includes these assets or you sell them as part of the proceedings, capital gains taxes will likely apply.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
