Divorced Couple - exwife purchases exhusband's share of home

[Yardley CPA]

Couple divorced for several years. Exwife continued to live in couples home and still does to this day. Divorce decree indicated that 50% of home belonged to exwife, 50% to exhusband. Exwife now wants to purchase the exhusbands interest. Here are the facts I received from my client (who is the exhusband):

- The home was purchased by both the exwife and exhusband ten years ago. The cost of the home was $169,000. An addition was added during the marriage that cost $24,000. So I believe the tax basis was approximately $193,000

- Fair market value of the home today (based on a home appraisal recently conducted) $335,000

- Exwife and exhusband agree to a buyout figure of $70,500 (that's the amount they agreed upon and exhusband is fine with this)

My question concerns the payment made to my client. I assume he is eligible for the $250,000 but should Schedule D be completed?

I wasn't sure if there was some other way of handling this? I had read something about it possibly being handled as a "gift" from the exwife to the exhusband.

Any information would be greatly appreciated.

[kcjenkins]

I would probably report it as a sale on sch D of a personal asset. Whether it is subject to the home sale exclusion depends on timing, but since his basis would be $96,500, I would not even bother with raising that issue. If there is a 'gift' involved, it would be from him to her, it seems to me, since he's accepting less than FMV. That's the thing I'd want to research before making a final decision.

[Richcpaman]

Transfers "incident" to the divorce are non-taxable.

Her buying him out is a non-taxable event and no reporting is required.

She does NOT get a step-up in basis for the payment, however.

Rich

[Yardley CPA]

Thank you both. In researching this a bit, I came across this article that speaks to the issue:

http://www.americanbar.org/newsletter/publications/gp_solo_magazine_home/gp_solo_magazine_index/weiler.html

I recognize the article is a bit dated.

[jklcpa]

Looks like you found your answer. Thanks for posting the link.

[kcjenkins]

That is a good link, thanks for sharing it. I hereby cancel my previous advice! Serves me right for not researching first. I would just add that if a 1099S is issued by the transfer agent, as frequently happens, I'd report it, as non-taxable, just to avoid the later automatic CP2000.

[Mr. Pencil]

Fair market value of the home today (based on a home appraisal recently conducted) $335,000... buyout figure of $70,500

I think your client needs to file a gift tax return because he transferred his ownership interest for less than FMV. Divorce rules don't apply since it was more than one year later and not pursuant to the decree. That is rebuttable so I'd want to read the actual decree and get more information, like the value at time of divorce and what other payments/transfers were or were not made.

[Yardley CPA]

Thanks for your input. I'm going to suggest to my client that we not report this on the return, unless, like KC mentioned, he receives a 1099S. I'll also ask to look over the divorce decree, as Mr. Pencil suggests.

[SaraEA]

Rich CPA man is right. I don't have my reference materials with me, but I seem to remember that transfers incident to divorce can go on for five years or so. (There used to be a lot of hanky panky in this area with spouses trying to make certain transfers look like alimony or not alimony.) You might consult a tax pro who specializes in divorce issues. There really are such people--they even have their own dedicated software which calculates some of these things.

And Yardley CPA, don't worry about tax articles being dated unless the Code in that area has changed dramatically. When you look at recent Tax Court decisions you'll find them citing as precedent cases that were decided in the 1950s and '60s. Unless there have been major changes in the Code or Regs, case law rules. Did you know that if an issue is brought up before the court and there is no relevant case law, the judges use Common Law of England for precedent? That dates back to before we declared our independence.

[Mr. Pencil]

certain transfers look like alimony or not alimony.)

That's one of the reasons I'd want to see the actual decree. If alimony stopped because of this transfer, there might be a tax effect. Otherwise, "incident to divorce" means ONLY one year, unless it is actually in the divorce decree.

[Yardley CPA]

I have an email into the client to obtain a copy of the decree. With that said, I'm fairly certain that the divorce was fainalized well over a year ago.

[kcjenkins]

If the transfer of property between spouses is pursuant to a divorce or separation instrument and the transfer occurs not more than six years after the date on which the marriage ceases, the transfer falls within I.R.C. § 1041. The implication here is that only transfers that are made pursuant to or under the obligations of a written instrument fall within the I.R.C. § 1041. The statute, however, does not appear to require a written instrument (generally described as a writing containing material settlement terms), which may be set forth in a divorce decree or, more typically, is referenced in a divorce decree as a separate agreement or a written separation agreement.

Another troubling aspect of this rule is that the transfer must be made within six years or else the presumption must be rebutted. Property is often transferred after six years, for example, where a house is retained to raise children of the marriage. After the children reach a certain age, the parties dispose of the house. If the disposition of the house occurs six years after the termination of the marriage, the exception has not been met, and the presumption must be rebutted.

We don't know if the 6 years was up before the sale or not, but even if it is, the presumption can still be rebutted, but in such a case I'd advise getting an attorney involved in preparing the grounds for the rebuttal.

[Richcpaman]

After that 6 year mark, I believe the spouse who left the house, if the house is SOLD, can still use the Sec121 exclusion even if they have not lived in the house for 10 years, as long as they met the use tests at the time of separation and the ex-spouse stays in the house.

So, in many respects, no matter what, the tax code tries to minimize the potential tax effects on the moving out spouse.

So, even in the above case, if the spouse who moved out is deemed to have "sold" his half interest for $70,500, he could still exclude it.

Rich

[Mr. Pencil]

I'd advise getting an attorney involved in preparing the grounds for the rebuttal.

There is an adversarial position in this. If the IRS accepts the transfer as either a gift or a property settlement, they may disallow the basis increase to the ex-spouse.

That isn't an issue for the tax preparer. We do not have to support our position at this point, nor even believe it to be correct! It just has to be a reasonable position with at least a one in three chance of being upheld.