Page 623 - TaxAdviser_2022

TAX CLINIC

When determining an equitable split of assets between parties,
advisers should calculate the future income tax liability associated
with assets such as retirement funds and highly appreciated stock
and consider it in the overall plan of equitable asset transfers between
spouses.

by the former spouses at the cessation of shortcomings related to division of the income-generating assets that the
the marriage. family businesses and executed a second transferee spouse needs to support his
It is not always possible or practical agreement with terms agreeable to both or her lifestyle. If the transferee spouse
to transfer assets when the divorce is parties. The court found the transfer was is under age 59½, a 10% penalty on
finalized. Sec. 1041 provides taxpayers made to effect a division of property at early withdrawal of retirement assets
additional time to plan for assets that the time of, and was related to, the cessa- is assessed.
are difficult to transfer, including closely tion of the marriage. Another strategy for transferring
held business interests, real estate, and The court in Belot held that Sec. income-generating assets is to shift
notes receivable assignments. 1041 applies to multiple divisions of low-cost-basis securities to the spouse
High-net-worth couples and those marital property. The court also found under Sec. 1041. If the securities were
owning family businesses often have that Sec. 1041 can apply to marital held more than one year, they can be
extended and complicated divorce pro- property that is sold between former sold and taxed at long-term capital
ceedings. Additional disputes can arise spouses and that jointly held business gains tax rates to generate cash. The
after the original divorce instrument interests qualify as marital property. transferee spouse is typically in a lower
is executed, resulting in transfers of Temp. Regs. Sec. 1.1041-1T(d), tax bracket and will benefit from a
property that would otherwise be taxable Q&A-11, provides that the transferee long-term capital gains tax rate that is
if they did not qualify under Sec. 1041. will have a carryover basis in the lower than the transferor spouse would
Courts do not focus solely on the origi- transferred property. Carryover basis have paid had he or she retained and
nal divorce instrument or timing of the will apply even if there is a bona fide sold the securities.
transfer but carefully consider whether sale of the property. The carryover basis When determining an equitable
the transfer was made to divide property rule applies whether the adjusted basis split of assets between parties, advis-
between the former spouses when the of the transferred property is less than, ers should calculate the future income
marriage ended. equal to, or greater than the fair market tax liability associated with assets such
In Belot, T.C. Memo. 2016-113, the value at the time of transfer and applies as retirement funds and highly ap-
husband was entitled to nonrecognition for calculating gain or loss when the preciated stock and consider it in the
of gain from the sale of his business transferee later disposes of the property. overall plan of equitable asset transfers
interests held jointly with his former It is important to note that the rules between spouses.
wife based on a second settlement agree- in Sec. 1041 differ from those in Sec. The parties should decide whether
ment. The taxpayers agreed in the initial 1015(a) for determining the basis of the primary residence will be retained
divorce decree to equal ownership inter- property acquired by gift. or sold prior to finalizing the divorce.
ests in family businesses. Within a year, Sec. 414(p) defines a qualified Sec. 121(b)(2)(A) provides for a
the taxpayers realized they could not domestic relations order (QDRO) as $500,000 capital gain exclusion from
act as equal business partners. Pursuant an order that assigns the payee’s rights the sale of a primary residence if the
to a second settlement agreement, the to receive benefits payable under a taxpayers resided in the home for two
husband sold his business interests to his retirement plan to an alternate payee. of the past five years. Sec. 121(b)(1)
former wife. Sec. 414(p)(1)(B)(i) provides for the provides for a $250,000 capital gain
The court rejected the IRS’s argu- tax-free transfer of retirement assets, exclusion on the sale of a primary
ment that the transfer did not qualify including stock options and deferred residence on a tax return with single
for nonrecognition of gain because it compensation plan assets, pursuant to or head-of-household status. However,
was not included as part of the original a divorce. careful drafting of the divorce decree
divorce decree. The taxpayers had agreed Often, the downside of a QDRO will allow each taxpayer to exclude
that their first agreement contained is that this is not a shift of currently up to $250,000 of capital gain from

14 December 2022 The Tax Adviser