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What does “incident to the divorce” mean to the IRS?

On Behalf of | Jan 14, 2023 | Family Law

If you and your spouse are able to negotiate your property division settlement, with the help of your legal teams, without having to rely on a judge to decide everything, you’ll likely reach an agreement that’s fair to both of you and that will let you move forward in good financial shape.

If you have considerable and/or complex assets that you’ll be dividing with your spouse, it’s wise to consult with your own financial and tax advisors (not those you’ve shared with your spouse throughout your marriage). They can help you determine not just the short-term value of various assets, but whether they’re going to be worth keeping over the long term.

One thing that many divorcing people are concerned about is whether they’ll have to pay capital gains tax when they file their income taxes on property they get in the divorce that has risen significantly in value since it was first purchased. This can be a particular concern when it comes to real estate, stocks and other assets that typically increase in value over time.

The good news is that the Internal Revenue Service (IRS) doesn’t tax capital gains (or provide relief for losses) when asset transfers are part of a divorce settlement. These transfers are considered “incident to the divorce.”

When in a property transfer “incident to the divorce?”

Under Section 1041 of the Internal Revenue Code, any transfers between former spouses throughout the first 12 months after the divorce is final are qualified. You don’t even have to provide documentary proof that it was part of the agreement.

After the first year and up until six years after your divorce was final, you can still avoid paying capital gains tax on these transfers. However, you need to be able to show that the transfer was part of your divorce settlement or court-ordered (either during or after the original settlement as a modification or amendment). Most assets don’t take that long to fully transfer over. However, land, businesses and other assets can take some time to fully transfer.

By having sound financial, tax and legal guidance throughout the divorce, you have a good chance of starting this new stage of your life as comfortably and securely as possible.