If you and your spouse have accumulated a fair amount of assets over the years, you can’t divide them all down the middle. Likely, you’ll each keep an equivalent share. That can mean transferring some titled assets like homes and cars and other significant assets like investment accounts into the other person’s name.
One big concern that people often have is what the tax consequences of these transfers will be – namely, will they have to pay taxes on any capital gains associated with these assets? If your spouse signs over the vacation home that was in their name to you, it could be worth considerably more than it was when it was purchased. That could be hundreds of thousands of dollars in capital gains.
Fortunately, the IRS recognizes that divorces involve a lot of asset transfers and associated capital gains (and losses). These are called Section 1041 transfers under the tax code, and they don’t have to be reported on your income taxes as long as they’re “incident to the divorce.”
What time period is considered “incident to the divorce?”
Any transfers between divorcing spouses within a year of the divorce decree are assumed to fall into this category. You don’t have to provide any documentation to prove that it was part of your divorce settlement.
Some transfers take some time to be finalized. That’s why even after that one-year mark (typically for up to six years), you don’t have to pay capital gains tax on a property transfer that’s incident to the divorce as long as part of the official divorce settlement or any amendment or modification to it.
Not having to worry about capital gains tax can make a significant difference in what you choose to seek or agree to as you and your spouse work out your property division settlement. We’ve simply given a brief overview here. It’s important to add a tax professional to your divorce team to get the best advice for your specific situation.