When a couple gets divorced, each may be determined to walk away from their marriage with an equitable share of their marital property as they negotiate their property settlement. However, achieving that goal requires much more than simply considering the face value of the assets in question. Real estate, stocks, bonds, and other property are subject to capital gains taxes when sold if they have increased in value relative to when they were purchased. That tax bill can potentially take a significant bite out of an asset’s worth.
Failing to consider how future capital gains taxes might apply to property received in a divorce settlement runs the risk of one or both parties ending up with unnecessarily high tax bills down the road. It is essential to understand how the transfer of property in divorce intersects with how capital gains tax is calculated, the factors that influence the amount of tax owed, and who will be responsible for paying the tax when an affected asset is sold to get a more accurate picture of each asset’s worth. This information, in turn, can help minimize tax liability for both parties when it is used to strategically guide their decision-making on how to divide property and whether certain assets should be sold as part of the divorce.
- Why Capital Gain Matters for Property Division in Divorce
- The Capital Gains Tax Exemption on the Family Home
Going through a divorce with complex property division?
Why Capital Gain Matters for Property Division in Divorce
Capital gains tax is a tax on the profit made from selling an asset, such as real estate or stock (the amount it sold for minus its cost basis). If someone owns an asset that has appreciated in value, this tax isn’t owed until it is actually sold and the gain is realized. The amount of tax owed will depend both on how long the asset was held and the income level of the person who owned it. In general, for assets that have been held for over a year, capital gains are considered long-term and are taxed at either 0%, 15%, or 20%, depending on income level and tax filing status. Short-term capital gains on assets held for less than a year are taxed as ordinary income.
According to U.S. tax code §1041(a), transfers of property “incident to divorce” do not result in a gain or loss, so capital gains tax does not need to be paid when property is divided up between ex-spouses as part of the divorce. However, each of those assets will retain its original cost basis. This means that property with similar face values at the time of divorce can be subject to significantly different taxes when it comes time to sell them. For example, stock that has appreciated to $75,000 from an original purchase price of $25,000 over many years would have much higher capital gains (and a higher tax bill) than $75,000 of stock that was purchased only two years before at $65,000.
The spouse who owns an asset will be responsible for paying any applicable capital gains tax if they decide to sell it after the divorce, unless that responsibility has been specifically allocated differently in their divorce agreement. Since a married couple filing jointly benefits from a higher taxable income threshold before reaching the increased long-term capital gains tax rates, and may also qualify for more favorable exemptions, it is often worth considering whether selling certain assets before the divorce is finalized is more beneficial than dividing them. It may be worth examining if it is more advantageous to sell certain assets before the divorce is finalized rather than dividing them. Similarly, a lower-earning spouse may owe less in capital gains tax on an asset if they keep and then sell it than a higher-earning spouse would. Making such decisions is best done with the guidance of a tax professional who can provide specific advice on a couple’s individual circumstances.
The Capital Gains Tax Exemption on the Family Home
Another important area in which marital status can have an impact on capital gains tax is in deciding whether to sell the family home as part of a divorce. Special rules apply for the sale of a home if you owned it and used it as your principal residence for at least two years out of the last five. For married couples who file their taxes jointly, meeting these requirements allows them to exclude up to $500,000 of gain on the sale of that home from their income and avoid paying taxes on it. For a single person, the maximum exclusion is $250,000.
This should be weighed in deciding the long-term financial impact of a spouse trying to keep the family home. If ownership is transferred to one spouse in the property settlement, they will only be able to exclude a single person’s share of capital gains after the divorce, but they will still have the same cost basis. If they find themselves having to sell the home shortly after the divorce because they can’t afford the monthly payments or ongoing maintenance, they may face an additional tax bill that might have been avoided or minimized had the house been sold as part of the divorce.
Again, consulting knowledgeable financial and legal professionals will provide insight into the potential impact of applicable tax law and enable fully informed decision-making. This will help avoid nasty surprises about who owes taxes after divorce.
Expert Legal Advice for Divorce Tax Issues
Anticipating the possible effect of capital gains tax liability is just one of the issues that can arise when couples divide their property in divorce. The more complex the financial picture, the greater the likelihood that an unforeseen complication or well-intentioned mistake could negatively impact your long-term financial well-being. The family law experts at Hoover Krepelka have decades of experience in navigating complex property division. We pair our expertise with that of financial professionals to determine the property settlement and tax strategy that will best protect your interests. To schedule a consultation, fill out the form below.
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