When a married couple decides to divorce, there are several steps and decisions that need to be made. One those issues incident to divorce is the division of property. State law governs the division of property during divorce. Depending on the state, the court will divide property either by equitable distribution or by community property. Equitable distribution is a fair distribution of the marital property, and is not always equal. Community property division is a more equal distribution.
Community Property
Several states utilize the community property distribution. During community property distribution, the property is first categorized as either community property or separate property. Separate property is property that a spouse had before the marriage, which includes inheritance, personal injury awards, and workers compensation (even if received during the marriage). Separate property is not subject to distribution during the divorce and remains with the spouse who owns it. Community property is any other property acquired during the marriage and is equally divided between the spouses.
Potential Tax Consequences for Community Property
The general rule is that there is no recognized gain or loss on the transfer of property between former spouses if the transfer is made pursuant to a divorce. The property transfer must be incident to a divorce. The transfer is incident to divorce if the transfer happens within 1 year after the day the marriage ends or the transfer is related to the ending of the marriage. The IRS includes annulment or state law violations in its divorce definition.
Generally, there is no gain or loss on property transfers during a divorce, but there may be some gift tax considerations. The federal gift tax does not apply to most property transfers between former spouses in regards to a divorce. These transfers usually fall under one of the exceptions. But if the transfer does not fall under an exception or only partially qualifies, the property must be reported on a gift tax return. The transferred property is not subject to the gift tax if it falls under any of the following exceptions: it is a settlement of support rights, it qualifies for the marital deduction, it was made pursuant to a divorce instrument, it was made under a written contract and the spouses were divorced within a specific period of time, or the transfer falls under the annual exclusion.
Importance of Speaking with a Lawyer
If you are considering divorce, it is important to speak with a qualified attorney. A skilled divorce attorney can help ensure your rights are protected. If you have questions concerning the divorce’s tax ramifications, contact an experienced accountant.
