If you and your spouse have a number of valuable and/or complex assets that you’re going to be transferring to one another (or maybe just from one person to the other) as part of your divorce, you don’t want to end up having to pay capital gains tax on assets you’re selling if you don’t have to.
That’s why the Internal Revenue Service (IRS) does not recognize capital gain or loss on property transfers that are “incident to the divorce.”
Understanding Section 1041 of the Internal Revenue Code
Transactions between ex-spouses that occur within 12 months of the final divorce decree are presumed to be Section 1041 transfers (named after the Internal Revenue Code). That’s true even if the asset was originally purchased after the divorce. No documentation is necessary to prove that the transfer was part of the property division in the divorce.
However, some transfers are more complicated than others. What if you’re not able to finalize the transfer within that one-year timeframe? A property transfer is still presumed to qualify under Section 1041 as long as it’s part of either a negotiated settlement or court order in the divorce (including any amendments or modifications to it). After six years, it’s going to take some work and evidence to show the IRS that a transfer qualifies under Section 1041.
Not having to pay capital gains tax can help the person who’s transferring an asset to their ex-spouse significantly. That can save a lot of money if an asset has increased substantially in value. This is common for assets like homes, land, stocks or a share of a business.
If you’re splitting considerable assets as you divorce, it’s wise to have your own financial and/or tax advisor on your divorce team. They can help you and your attorney as you consider the short-term and long-term pros and cons of various property settlements in your divorce.