Tax Implications of Property Transfers During a Divorce

Property division is usually a critical financial aspect of the divorce process. While the emotional aspects of divorce may take precedence in many cases, it is essential to consider the tax implications of property transfers during this time. A reliable family law attorney can help you make informed decisions and avoid potential financial pitfalls.

Tax Treatment of Different Types of Property in Alabama

• Marital Home: When transferring the family home, you should be aware of the capital gains tax implications. If you sell the home, there is a potential capital gains tax exclusion as long as you meet certain criteria. Taking this into account, if one spouse retains ownership and sells it later, they might not be eligible for this exclusion.
• Retirement Accounts: Transferring retirement accounts, such as 401(k)s or IRAs, typically requires a Qualified Domestic Relations Order (QDRO). Depending on the timing and method of withdrawal, there may be tax consequences and early withdrawal penalties.
• Investment Properties: Transferring investment properties can trigger capital gains taxes. Be aware of the tax basis, potential depreciation recapture, and the timing of the transfer.

The tax implications of property transfers during a divorce can significantly impact your financial well-being. It is important to work closely with strategy-driven divorce attorneys who can provide legal guidance and help you save taxes depending on your specific situation.

Alimony vs. Property Transfers to Save Tax in Alabama 

Alimony payments are generally tax-deductible for the payer and taxable as income for the recipient. With the Tax Cuts and Jobs Act (TCJA) that took effect on January 1, 2019, there was a significant change in the tax treatment of alimony. For divorce agreements finalized after this date, alimony is no longer tax-deductible for the payer, and recipients no longer report it as income.

Property transfers, on the other hand, typically do not have immediate tax consequences. Moreover, understanding the long-term implications, such as capital gains on eventual sale, is important. The tax consequences of property transfers are often deferred until the recipient sells or disposes of the transferred assets. At that time, capital gains taxes and other potential taxes may apply, depending on the asset’s value and tax basis.

You should consult with a knowledgeable and experienced divorce attorney who specializes in divorce and tax matters. They can help you work through the complexities and make informed decisions.

Other Tax Factors to Consider During Property Transfer 

Cost Basis and Capital Gains

The cost basis of an asset is essentially the original value or purchase price of that asset. It serves as a reference point for determining capital gains or losses when the asset is sold or transferred.

When property is transferred during a divorce, the receiving spouse generally assumes the transferring spouse’s cost basis. This can impact capital gains taxes when the property is sold in the future. Properly documenting the transfer and retaining records is essential for accurate reporting.

If the recipient spouse eventually sells or transfers the property, they may be subject to capital gains tax based on the carryover basis. This means that the original purchase price and any improvements made by the transferring spouse will factor into the calculation of gains.

Depreciation Recapture

If rental or business property is involved in the divorce, be aware of potential depreciation recapture. Depreciation claimed on the property over the years might need to be recaptured as income when the property is sold or transferred.

When depreciation recapture occurs, the IRS “recaptures” some of the previously deducted depreciation by taxing it as ordinary income rather than as a capital gain. This means the recaptured depreciation is subject to ordinary income tax rates, which can be higher than capital gains tax rates.

In many divorce property transfers, the receiving spouse typically assumes the transferring spouse’s adjusted basis, which includes any depreciation deductions taken by the transferring spouse. It is vital for both spouses to maintain detailed records of the depreciation claimed on the property during the marriage. These records will be essential for accurately calculating any potential depreciation recapture in the future.

Tax Consequences for Transferring Jointly Owned Property in Alabama

The specific tax consequences can vary depending on the type of property and how it is being transferred. If the jointly owned property is your family home, you might be eligible for a capital gains tax exclusion. Under current tax laws, if you meet certain criteria, you can exclude up to $250,000 (or $500,000 for a married couple filing jointly) in capital gains when selling the home. To qualify, you typically need to have owned and lived in the home as your primary residence for at least two of the last five years.

For other jointly owned real estate assets, such as investment properties or vacation homes, the tax consequences can be different. The gain from the sale of these properties may be subject to capital gains taxes. The tax rate can vary based on factors like your income level and the length of time you have owned the property.

Get a Knowledgeable and Compassionate Family Law Attorney on Your Side

The experienced divorce attorneys at Wilkins, Bankester, Biles & Wynne, P.A. have a deep understanding of family law, ensuring that your case is handled with professionalism. Our lawyers recognize that every divorce is unique and create strategies based on your specific needs and goals. Schedule your case review with our lawyers today. Call us at 251-928-1915 or contact us online.