Could keeping the house leave you holding the bag? What exactly are the possible tax implications of divorce?
While a divorce might leave you feeling like your spouse just hit the lottery. The IRS doesn’t see it that way. The transfer of assets from one spouse to another incident to divorce is non-taxable. But that doesn’t mean there aren’t tax implications.
A fundamental part of divorce is dividing your assets and debts. In Nevada, community property is divided equally between spouses. This doesn’t always mean each spouse gets half of each asset. It just means you each get half of the whole. So each person might keep their own 401k, vehicles, and credit card debts, leaving a slight imbalance to be offset by an equalizing note – a cash payment from one spouse to the other to equalize the division of assets.
Dividing assets this way is practical for many reasons. Dividing a 401k or pension requires a Qualified Domestic Relations Order, which can be costly. Each 401k or pension to be divided requires a separate QDRO. Rather than pay a couple thousand dollars to divide all of the retirement accounts, it might be more cost effective for each spouse to keep a whole account and use a different retirement account to offset the difference.
We are often aware of the tax implications of how retirement accounts are divided. An attorney would never offset a savings account with retirement savings. The regular savings account is a liquid asset that has already been taxed. It can be accessed immediately without tax implications, whereas retirement may not be accessible for several years and is often a pre-tax asset. In this regard, your attorney is considering the tax implications of dividing certain assets.
But there may be another tax trap lurking in the shadows. And it has to do with what you plan to do with assets after your divorce. While the transfer of the asset is not taxable, the subsequent sale of it is. And the tax basis is not the value at the date of transfer. The original basis follows the asset.
What exactly does that mean in the real world? Well, it means that if your spouse bought Apple stock in the early nineties and you got half that account in the divorce, thinking you would be able to live out your days once you cashed it in- you might actually pay some pretty serious capital gains taxes when you sell it.
Likewise, let’s say you and your spouse bought a house in 1998. As the market improved and the value of your home increased, you refinanced and took out additional monies against the value of your home. Maybe it was for a new roof, or your kid’s college tuition. Whatever it was, the house you bought has quadrupled in value, but doesn’t have much equity because you’ve continued to borrow against it. You might be able to keep the house in the divorce by buying your spouse’s interest for relatively little. But if you plan to sell the home down the road, you’re the one who will be bearing the taxes for the sales price less the cost basis- not just the net proceeds. Depending on the price of your home, this could be substantial. There are special capital gain provisions on the sale of a home, which you need to discuss with your accountant.
When considering a divorce, make sure you talk with your attorney not just about where you are right now, but what your plans for the future are. They could have a significant impact on your financial situation post-divorce.
Gloria Petroni is a licensed Nevada Attorney with over 40 years of experience. She is a family law specialist and practices in the areas of family law, probate and estate planning. This article is meant to be informative. It is not a substitute for legal or tax advice. Every case is different. If you have questions about your case, you should contact a Nevada licensed attorney. If you have tax questions, you should contact your CPA.