Tax Considerations When Dividing Marital Property
By Heather Santonino, CPA, Director, Tax & Business Services
While the fair market value of jointly owned property is a major focal point during a divorce, it’s important not to overlook a property’s tax basis. The basis of property acquired in a divorce is generally the basis of the property in the hands of the transferor (under IRC Code 1041). For example, let’s say there are two jointly owned assets that are both valued at $500,000. The first asset is public stock with a cost basis of $100,000. The second asset is undeveloped land that was held for investment with a cost basis of $250,000. Since both assets are valued at the same amount, it may seem fair for one spouse to get the stock and the other to get the land — that is, until the asset is sold and the tax bill arrives.
Say selling the stock resulted in a capital gain of $400,000. Assuming a federal capital gain tax rate of 20%, the tax due is $80,000 (this is ignoring net investment income tax and state taxes). At the same 20% rate, the tax due on the sale of the land is $50,000. After the sale, the stock nets $420,000 and the land nets $450,000. One spouse is ahead $30,000 in this example.
Tax carryforwards should also be considered when dividing assets given the potential tax consequences and tax planning opportunities. Spouses should consult with a CPA to help identify tax considerations and the impact on each spouse. There are many carryforwards that may or may not be available depending on specific facts and circumstances. Some common carryovers are capital loss carryovers, net operating loss carryovers, excess business loss carryovers, business tax credit carryovers, investment interest expense carryovers, and suspended passive activity loss carryovers. When tax regulations don’t specify how the carryforwards should be allocated between divorcing spouses, the couple must allocate the carryforwards themselves. This should be properly documented as part of the negotiations.
Not every divorce will require a detailed analysis of tax basis and carryforwards, but they should always be considered during negotiations. Reviewing the last income tax return(s) filed by the spouses is critical. Engaging a CPA to prepare an independent analysis of the tax consequences under different scenarios could result in significant tax savings for your clients. Please feel free to contact the Marcum Matrimonial Team if we can be of any assistance.