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Understanding what “incident to the divorce” means to the IRS

On Behalf of | Jun 14, 2023 | Child-Related Matters

When sorting out the property division aspect of divorce, it’s always wise to determine the financial and tax implications of any property you take in the settlement. What may seem like an asset worth fighting for, like a home, can end up being far more costly to maintain over the long run than you anticipated.

One thing that causes concern for many couples is whether they will have to pay capital gains tax on an asset they acquire from their spouse in the divorce that has increased significantly in value. This can include anything from real estate to investments to businesses and more.

How long can transfers be “incident to the divorce?

Fortunately, the IRS recognizes that numerous transfers of property may take place as part of a divorce agreement. That’s why capital gains and losses on transfers “incident to the divorce” (also called Section 1041 transfers) aren’t considered when filing your income tax return – at least the first one after your divorce.

Further, you don’t need to provide any documentation to the IRS to prove that a transfer was part of a divorce settlement as long as the transfer (for example, the title change) is finalized within a year after the divorce decree is issued.

What about transfers after a year?

What if an asset transfer, such as a piece of land or maybe a business, takes longer than a year to finalize? If a transfer that’s finalized more than a year after the divorce decree is signed (as long as it’s within six years), you will need to provide documentation showing that the transfer was addressed either in the original divorce settlement or any court-approved modifications to it.  

If you are dividing valuable and/or complex assets in your divorce, it’s probably worth your time and money to add financial and tax professionals to your divorce team. With sound legal and financial guidance, you can work toward the best division of property agreement for you in both the short and long term.