Although the IRS does not generally consider the transfer of assets between divorcing spouses a taxable event, those who are not aware of what the tax implications of their divorce are may later stand to lose a great deal of money (and assets) if they are not aware of what those implications are.
What are some Commonly Taxed Items and Events that I Should Look Out For?
There are quite a few big ticket items that one must be aware of when considering the tax implications of divorce. Failure to consider the tax implications of an item in advance may end up causing the spouse that retains that asset to have to sell it in order to pay the taxes:
- Family Home: The home is usually the most expensive asset owned by a couple. Upon divorce, couples end up arriving at one of three solutions for distributing the home:
- Sell the home immediately and divide the proceeds
- Sell at a future date
- One person buys the other's interest in the property. Depending upon the status of the couple, the parties may choose to do different things with the family home
- Couples under age 55: If the home is the principal residence, taxpayers have a two year window to reinvest their money to avoid capital gains tax. Problems arise when an ex-spouse lives in the home for more than 2 years after divorce. Big capital gains may be taxed on the other spouse when the home is eventually sold as the principle residence rule no longer applies.
- Couples over age 55: The process of selling shared assets is even more complex as a couple ages. Couples over 55 qualify for capital gains exclusions up to $125,000. If couples wait until after divorce, each individual qualifies for a $125,000 exclusion resulting in a $250,000 combined tax shelter. If the home is worth more than $125,000 then one should wait until after divorce to sell.
- Mutual Funds, Stocks, Bonds, Artwork and Other Appreciating Items: Appreciating assets or belongings that many couples collect must be distributed and divided during a divorce.
- Stocks: Although stocks would normally be taxed upon gains over the period of investment, in the divorce buy-out setting (one spouse buys the other spouse's interest) they pay taxes on their original investment, not the total investment money put in to buy out their former spouse. Meanwhile the money paid to the other spouse goes to them tax-free.
- Retirement Funds: Tax laws governing retirement plans are strict and govern not only who receives the distributions, but also how they are handed out. The laws are also strict regarding the plan owner's spousal rights. Your ex-spouse is entitled to some portion of the distribution plan. IRAs on the other hand, are generally considered the property of its owner. This assumes that there have been no contributions from earnings made during the marriage.
- Dependency Exception: The custodial parent generally gets a dependency exemption when filing taxes. This is usually more important for lower-to-middle-income taxpayers, especially if there is a significant difference between the earnings of the two seeking the divorce. Regardless of custody, both parents may deduct medical expenses.
Should I Contact a Lawyer Regarding the Tax Implications of My Divorce?
Divorce has far-reaching tax implications. If you want to maximize your assets and be able to retain them after divorce, it is a good idea to contact an experienced tax and/or divorce attorney to help you structure your divorce.