Property Settlements and Third-Party Transfers

Monica McCarthy |

Property Settlements and Third-Party Transfers

What are property settlements and third-party transfers?

When marital separation occurs and a divorce is contemplated, spouses must decide how to divide their property. Property includes such assets as the family home, rental property, automobiles, pensions, bank accounts, and stocks and bonds. It also includes art and antique collections, furniture, IRAs, life insurance cash values, and family businesses. A formal property settlement agreement is usually drawn up and signed by the couple, formally assigning assets to one spouse or the other. In some cases, the couple may decide to sell one or more assets to a third party, splitting the proceeds. This type of transaction is known as a third-party transfer.

Although it's important for divorcing spouses to understand the property laws regarding the division of marital property, it's also essential for them to understand the tax implications of their decisions.

How is property classified for divorce purposes?

Assets are divided in accordance with state laws, and states can be divided into two categories, based on their property division rules: community property states and equitable distribution states.

Community property states

In general, community property states focus on the difference between separate property and community property. Separate property is that which you bring to the marriage, including inheritances and gifts received prior to marriage. Community property, on the other hand, may be defined as property acquired during the marriage (except for inheritances and gifts received during the marriage). Separate property can usually be kept by the owner-spouse after a divorce, while community property must be divided equally (50/50) rather than fairly between the spouses.

Example(s): Assume John and Mary are married and live in California, a community property state. Prior to their marriage, Mary received a $50,000 inheritance from her grandmother. During the course of their marriage, Mary received a $20,000 inheritance from her aunt. John and Mary bought a $500,000 house together during their marriage and amassed a $50,000 savings account. If John and Mary seek a divorce, both of the inheritances are considered separate property and will go to Mary only. However, the house and savings account are considered marital property and must be divided equally (50/50) between John and Mary. That is, each spouse will get $25,000 from the savings account and $250,000 in cash (or assets), assuming that the house is worth $500,000 on the date the spouses select for valuation.

At present, the following are community property states: Alaska (which has an optional system), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin (and also Puerto Rico).

Equitable distribution states

The majority of states follow an equitable distribution philosophy. These states agree that marital property should be divided equitably (fairly) rather than equally. Some of these states will include separate property (such as inheritances and gifts) in equitable distribution, and some will not.

Equitable distribution states fall into three categories, based on how they identify marital property.

  • Type 1--The first type of state identifies marital property as all property except that which either spouse brought into the marriage or obtained by gift or inheritance at any time. This definition is identical to that espoused by the community property states. The difference is that marital property will be divided equitably, as opposed to equally.
  • Type 2--The second type of equitable distribution state proclaims that regardless of how or when property was acquired, all property (of both spouses) is subject to division at divorce. These states don't differentiate between marital and separate property. They divide property fairly and equitably and may allow property brought into the marriage by gift or inheritance to go to the other spouse if this form of distribution seems more fair, all things being considered. However, the source of the property (i.e., gift, inheritance, owned prior to marriage) is often very important in the judge's decision-making process.

Example(s): Assume John owned a $10,000 savings account and a $100,000 house. When he got married to Mary in a Type 2 equitable distribution state, he kept the title to these assets in his name alone. During the course of their marriage, the couple bought a vacation condominium in Florida and two automobiles and amassed $100,000 in mutual funds. If John and Mary seek a divorce, all of the property (including John's house and personal savings account) will be subject to equitable distribution principles.

  • Type 3--The third category of equitable distribution state favors a mix of rules. Such states use fairness as a means of division but don't exempt all gifts, inheritances, and property brought into marriage from division. Instead, they may exempt one or more of these types of property.

Tip: To determine which category your state falls into, check the domestic relations laws of your state or consult with an attorney.

How is property valued?

Once property has been classified as marital or separate, the next step in the process is to establish values for all of the identified property. Valuation may be by mutual agreement of the spouses. Certainly it's a simple matter to ascertain the fair market value of bank accounts, stocks, and bonds. And the fair value of household goods is usually determined by mutual agreement. However, in complicated cases involving pensions, family businesses, real estate, stock options, and so on, both sides may need to hire experts to establish values. This may be particularly true if your state recognizes professional licenses, advanced degrees, and enhanced earning power as marital property.

Example(s): Assume two premed students, Mary and John, got married. The couple agreed that John would complete his education first, while Mary supported him. When he finished, she would then complete her education. After John's second year of residency, he decided to divorce Mary. The court decided that because John's medical school degree and license to practice were both obtained during the marriage, they should be considered marital property, subject to valuation and division. An expert provided the court with present-value calculations of John's future earnings and came up with the figure $500,000.

Tip: In second marriages, sometimes a house is brought into the marriage. When such a house appreciates in value during the course of the second marriage, valuation can be a problem. Keep in mind that although separate property may not be subject to division in some states, the appreciation in value of separate property during the course of the marriage may be subject to division, particularly if both spouses used the property and contributed to the increased value.

Example(s): Assume Mary owned a $100,000 house with a $60,000 mortgage when she entered into a second marriage with John. Mary kept the title to the house in her name but lived there for many years with John. Mary now wishes to divorce John. The house is presently worth $160,000, and the mortgage has been brought down to $40,000. How should the property be valued?

Example(s): Mary may assert that the only marital asset is the increase in property value--$60,000. She obtained this figure by subtracting $100,000 from $160,000. John could argue that the increase in equity (not the increase in property value) is the marital asset. This figure would amount to $80,000 ($120,000 equity minus $40,000 equity). In most states, there is no definitive answer--the parties will have to agree or a court will have to decide.

Caution: The concept of gifting must also be considered when discussing valuation. In this example, if Mary had added John's name to the deed during their marriage, nearly all courts would hold that Mary converted the separate property into marital property. Thus, the entire house would be subject to division rather than the mere increase in appreciation.

The date of valuation is a matter usually determined by the parties themselves. For example, a couple might agree to value assets as of the separation date or at another mutually acceptable time. In some states the date of valuation is the date of the divorce trial.

How do you approach property division?

The division of property will eventually be reduced to a written agreement--the Property Settlement Agreement. A property settlement agreement, once it has been signed by the parties, is a binding agreement and becomes part of the divorce decree. In cases where alimony or child support is needed immediately, a temporary order is often sought first.

When considering the division of property, both spouses must gather information about their assets. If you hire a divorce attorney, he or she will want to see financial statements from each spouse. It is necessary to know the amount, the frequency, and the source of periodic income. Likewise, parties must disclose the sources, locations, and fair market values of their assets. Of course, debt must also be disclosed.

There are occasions when one spouse has been kept in the dark about financial matters or perhaps chose not to take an active role. For example, one spouse may have handled the bills, bank accounts, and securities, while the other cared for the children and ran other domestic affairs. In legal terminology, the discovery process will help the less financially savvy spouse gather the necessary information.

During discovery, a spouse can request copies of income tax returns, any insurance policies that may exist, credit reports, employee benefit statements and summaries, bank account summaries, and other documents. Written questions (called "interrogatories") about income, assets, debts, and documentation may be served on (and answered by) the other spouse. Also, depositions of each spouse may be taken.

What about hidden assets?

Sometimes, when a marriage has been deteriorating for many years, one spouse will hide the existence of assets from the other spouse in the expectation that a divorce may occur someday. If you find hidden assets, you will probably want to reveal them prior to trial in order to obtain your spouse's consent to a more equitable settlement. However, you can also choose to wait until the trial, undermining the credibility of your spouse.

Example(s): John handled the finances in his family and secretly stashed away $50,000 in a bank account during the last years of his marriage. When divorce proceedings began, he wire-transferred the money to his mother, a resident of Columbia. John's wife, Mary, learned of the money when she found a receipt for the wire transfer in her husband's coat pocket. Since John had not disclosed the existence of this money at discovery or in his financial affidavit (submitted to the court), Mary was able to use this fraudulent transfer as leverage to force a favorable property settlement.

There are a number of places where you can look for hidden assets:

  • Personal income tax returns--A review of the personal returns filed for the past five years may indicate sources of interest or dividends. They may also reveal unknown sources of income or loss from trusts, partnerships, or real estate holdings. You should review federal, state, and amended returns, comparing them to 1099s and W2s.
  • Partnership tax returns--Compare partnership returns (IRS Form 1065 and Schedule K-1) over a number of years to see whether any sudden changes in the partnership interest or distribution occurred around the time of a marital separation. (Sometimes, compensating adjustments are made after the divorce has been finalized.)
  • Corporate tax returns--If one spouse is the principal owner of a closely held business, he or she may be manipulating salary by taking loans from the corporation or may be charging personal expenses to corporate accounts. Corporate returns should also be checked for excessive retained earnings, as this may disguise available profits or an artificially low salary level.
  • Financial statements--If your spouse took out a loan for his or her business or for personal purposes, he or she submitted a financial statement to the lending institution. Look back at these statements for a five-year period to find assets that may no longer be accounted for.
  • Savings account passbooks--You should acquire the passbooks for any savings accounts opened in the last five years, looking for substantial withdrawals close to the time of separation. Also, periodic withdrawals (or deposits) could indicate mortgages (or income) from hidden sources.
  • Canceled checks and check registers--You may come across canceled checks for the purchase of property that you never knew existed. Compare the canceled checks against the applicable bank statement to make sure that you were given all of the canceled checks (some may have been removed by your spouse).
  • Securities statements--Brokers furnish periodic statements, indicating transactions involving stocks and bonds. A review of these statements may raise a question about sales proceeds--where did the money go? You can cross-check securities transactions with bank account information by date and amount to see what may have happened.
  • Uncollected bonuses and commissions--By subpoena, check with your spouse's employer to learn if any bonus or commissions are being held back.
  • Children's bank accounts--Sometimes, a spouse who wishes to hide money will open a custodial account in the name of his or her child. If the annual interest from this account is less than the standard deduction amount for a dependent for that tax year, it's not shown on income-tax returns, nor are returns filed for the children.
  • Phony loans, debts, or employees--To keep cash from being divided, a spouse may suddenly announce that he or she needed to repay a relative or friend for a loan made many years ago. These loans are suspect if made proximate to the marital separation. Also, if one spouse controls the payroll of a sole proprietorship, partnership, or closely held business, he or she may have a relative or friend on the payroll who's not really providing adequate services for the business. Thus, the business's profits will be reduced, and your spouse may be drawing a lower salary and getting a kickback.

In what ways may property settlements be structured?

Property settlements may be structured in a number of different ways.

Equal divisions

You begin by listing all of the marital assets (and their corresponding values). In a 50/50 split, of course, each party would be given one-half of the cash value of the assets. But perhaps one spouse might want to keep the entire house and one-half of the savings account, while the other spouse might want to keep the entire pension, one-half of the savings account, and the sole proprietorship. An example will illustrate that one spouse might end up owing the other spouse money if a 50/50 split is necessitated.

Example(s): Assume John and Mary have been married for 20 years and are now seeking a divorce. They own a house (worth $150,000), a pension (valued at $80,000), a savings account (worth $30,000), and a sole proprietorship (Acme Industries, estimated at $100,000). They don't want to sell assets and split proceeds; rather, Mary and John have tentatively decided to divide their assets as follows:










Savings Acct.



Acme Ind.









Example(s): If a 50/50 property split is contemplated, John will owe $15,000 to Mary. In this example, the appropriate division can be accomplished with a property settlement note. John can make monthly payments to Mary (with interest) until the $15,000 has been paid in full.

Property settlement note

A property settlement note is a promise from the payer to the payee to pay a particular sum, for a particular length of time, with reasonable interest. The note should be collateralized. For tax purposes, the note doesn't represent alimony; it's purely a property settlement. Therefore, the payer can't deduct these payments from income. Likewise, the recipient doesn't include the principal payments in income (but he or she does include the interest portion in income).

Caution: Also, keep in mind that a property settlement note can be discharged in bankruptcy, whereas alimony and child support payments cannot.

Equitable divisions

A 50/50 split may not produce equal results--or equal standards of living after the divorce--if the two spouses are unequally situated after the divorce. For example, an older homemaker who sacrificed her career for the care of her children and the upkeep of her home may not be able to maintain a standard of living equal to her former spouse after a divorce, even with a 50/50 split. Later in life, her husband may command a top salary, while she has no work history and few marketable skills. After a divorce, he will continue to reap a high income, while she will need to receive alimony or be required to drain assets.

Another example involves separate property. If the homemaker wife, for example, has $4 million worth of separate property sitting in a trust fund, a judge may find that a 50-50 split of the marital assets would be inequitable to the husband. States that use equitable principles in dividing property may consider a number of factors, including the following:

  • Contribution by the spouses--Courts will consider financial contribution to assets and also non-economic contributions, such as homemaker services (child-rearing, housecleaning, career-sacrifice, etc.). Some states will assume that the contributions of a homemaker are equivalent to the contributions of the full-time wage earner, while others will admit expert testimony to place a value on homemaker services.
  • Courts will also look at contribution by one spouse to the education of the other spouse. As cited in an earlier example, one spouse might work to put another through medical school. The increased earning power of the doctor-spouse might be viewed as "property" in some states.
  • Duration of marriage--In a short-term marriage, direct financial contribution to assets plays a larger role, whereas in a long-term marriage, greater weight is given to noneconomic contributions, such as homemaker services.
  • Future financial needs--Some states will consider the future financial needs of the spouses and/or the children when dividing property. While this is seldom a factor in marriages of very short duration, it can be a factor in long-term marriages.
  • Income--If the income of one spouse differs substantially from that of the other spouse, this may influence the judge's division of property. For example, the judge may award a higher percentage of the property to the more dependent spouse, or alimony payments may be ordered.
  • Assets and separate property.
  • Extent of debts and ability to pay.
  • Age and health of the spouses.
  • Employability and future earning capacity.
  • Educational degrees and professional licenses--When a spouse's education, degree, or training received during marriage substantially enhances that spouse's earning capacity, a court may order that spouse to compensate the other spouse for financial support and reduced discretionary income during the educational process. For example, the court may:
    1. Reimburse money spent on tuition, student loans, books, supplies, and other educational costs
    2. Allocate balances remaining on student loans solely to the educated spouse for repayment
    3. Use alimony to compensate the nonstudent spouse for financial and emotional support

Tip: Alternatively, of course, the court may determine that the degree or license is marital property, subject to division. As was mentioned earlier, a present value of future earnings might be divided between the spouses in such a case.

  • Tax consequences.
  • Financial and emotional needs of the children--Note that a marital home may be given to the custodial parent if minor children are involved.
  • Standard of living during the marriage.
  • Fault (in some states).
  • Conduct during the marriage (in some states).

What are the tax implications of property dispositions?

Property transfers between spouses during the marriage or incident to divorce aren't taxable. However, the tax effects of property dispositions can vary greatly, depending on whether you decide to transfer property immediately to your spouse, sell it to a third party, or sell it to your spouse at some future time.

Transfer to spouse incident to divorce

Neither spouse recognizes gain or loss if you transfer the title of the property to your spouse incident to a divorce. A transfer of property is viewed as incident to divorce if the transfer occurs within one year after the date on which the marriage ends or if the transfer is related to the ending of the marriage. Any transfer of property between spouses that is made pursuant to a divorce or separation instrument and that occurs within six years after the date the marriage ceases is presumed to be related to the cessation of the marriage.


The spouse receiving the property takes the basis of the transferring spouse. This result occurs even if the spouse that retains the property pays cash or other assets in return for the property and the transaction is basically a sale.

Example(s): Assume Mary sells her half-ownership interest of their home to her spouse, John, for $85,000 as part of their divorce settlement. Because the property had initially been purchased for $80,000, Mary's basis was $40,000 and John's was $40,000. Mary doesn't recognize any gain on the sale to John because the sale was incident to their divorce. John's basis in the property will be $80,000.

Sale of property to third party immediately

Often, a piece of property will be sold to a third party as part of a divorce settlement, and the proceeds will be split between the spouses. In such a case, each spouse will recognize one-half of the gain on the sale (unless they qualify for a capital gains exclusion).

Delayed sale

The parties might decide that the property will be sold to the other spouse at some point in the future. If sold later than six years from the marriage cessation date, the sale will generally not be considered incident to the divorce. Thus, the seller will recognize capital gains and losses. This is not to be confused with the promissory note arrangement mentioned earlier.

Tip: While a sale made more than six years after the marriage cessation date is presumed not to be incident to the divorce, the presumption will not apply if it can be demonstrated that the transfer was made to carry out the division of property owned at the time the marriage ended. For example, a sale might be considered made incident to a divorce if business or legal factors prevented an earlier transfer of the property and the transfer was made promptly after those factors were taken care of.

Is the family home given special treatment?

With respect to ownership and division of the family home, special rules apply both in community property states and in equitable division states. In a community property state, the family home can be considered marital property even if one spouse separately brought it to the marriage. This is true if both spouses lived in the home during the marriage and also if the nonowner spouse contributed to the house's appreciation in value over the years. In equitable distribution states, a court will consider numerous factors when deciding on an award of the house.

So, then, to whom does the house belong? Title on the deed is certainly a useful starting point, but it also depends on whether you live in a community property state or an equitable distribution state. It further depends on whether you owned the house prior to marriage, whether you received the house as a gift or inheritance, and whether both spouses lived in the house during marriage. It's important, therefore, to review the domestic relations law of your own state to answer this question satisfactorily. Nevertheless, in general, it's safe to say that both spouses probably have a claim on the house and should prepare to divide this asset along with other marital assets.

What can be done with the house when a divorce arises?

When considering the issue of who gets the house, there are four options that are most frequently used: sell the house, have one spouse buy out the other's half, have both spouses continue to own the property jointly, or simply agree that the homemaker spouse (if any) should get the house along with other assets.

Sell the house

Selling the house and dividing the profits that remain after the mortgage is paid off and the selling costs have been paid is certainly one of the easiest ways to deal with the marital residence, particularly when there are no children involved. Profits can be divided equally or otherwise, based on the parties' wishes. Most people will want to have an independent appraiser value the property, hire a real estate agent to sell it, consult with a real estate attorney, and obtain a mortgage payoff figure. These selling costs can sometimes be significant. For information about deducting settlement costs and other costs involved in the sale of a house, see Selling a Home.

Of course, the divorcing spouses will both need to find new residences and weigh the costs and benefits of purchasing a new home versus renting an apartment. If there are no children, selling the marital residence is probably a much simpler solution for a younger couple than for an older one. An older spouse, particularly a homemaker, may have stronger emotional ties to the home and may fear the loss of security associated with a sale of the home and a new life in an apartment.

Buy out the other spouse

If one party wants to keep the family home, buying out the other spouse might be an attractive solution. You can buy out your spouse by trading another asset (like a pension) or foregoing alimony, by paying in cash, or by granting a mortgage (or second mortgage) to your spouse.

If you want to buy out your spouse, the first thing you'll need to do is to value the property. An independent appraiser should be hired to fix the value. Next, obtain a mortgage payoff figure (if any). The value minus the mortgage shall be viewed as your equity in the property and, once divided in half, can serve as the buyout figure. Alternatively, of course, the couple can decide on a buyout figure of their own choosing; it doesn't necessarily have to be one-half of the equity.

The method of payment is the next question to be considered. Certainly, trading assets is one option. For example, if one half of the net equity in the house amounts to $25,000, and one spouse has a pension worth approximately $15,000, the other spouse might want to relinquish his or her rights in the pension in return for keeping the house. Of course, the other spouse needs to carefully weigh such a decision, in light of the fact that the pension will probably increase dramatically over the years and he or she may be left with no retirement income.

A cash exchange is another method of payment, if one party has an inheritance or trust fund. Refinancings and mortgages should also be considered. The house could be refinanced to provide enough cash to pay the other spouse. Alternatively, a note payable (with reasonable interest) or private mortgage can be drawn up between the spouses. However, this approach could present some problems.

Example(s): Mary and John are seeking a divorce and own a home with $20,000 worth of equity. Mary wants to keep the house, but has just started a new job, and doesn't have sufficient cash on hand to buy out John. Mary promises to make a balloon payment of $10,000 to John seven years after their divorce date, securing this promise with a $10,000 private mortgage to John. When Mary tries to refinance the house some years later in order to pay off John, she finds that conventional mortgage lenders will not grant her a mortgage unless John subordinates his mortgage claim to theirs. If John refuses to subordinate, Mary will have difficulty finding the cash to pay off John.

Tip: If private notes and mortgages are to be used, the divorce agreement should stipulate that subordinations and other accommodations will be freely given by the creditor-spouse. Also, if one spouse merely deeds his or her interest in the house to the other spouse while a mortgage is outstanding, both spouses shall remain liable for the mortgage (if both signed the mortgage initially). If the spouse who lives in the house stops making mortgage payments, the other spouse may be liable and may suffer severe credit consequences.

Joint ownership

This option is often used when the parties envision selling the house at some point in the future (e.g., when the minor children reach age 18 or when the resident spouse remarries). The parties might agree that the spouse who lives in the house shall be responsible for making the mortgage payments or that both parties will pay the mortgage, insurance, and taxes until the children graduate from school.

Property values should be a concern, however, if you promise to pay a certain dollar amount in the future. Rather than promising to pay $20,000 when the property is sold 15 years from now, you might wish to promise one-half or one-third of the net sale proceeds. This would protect the resident spouse if the property value declines. If you're the creditor-spouse, a dollar amount might be better.

Agree to give to homemaker

There are cases when assets won't be traded in any significant sense; rather, the parties will simply agree to give the greater portion of assets to one spouse. This can be particularly true when a homemaker of many years is involved. For older women who sacrificed a career for the care of children and the upkeep of a house, it may be impossible for them to jump into the working world at age 58 and earn a sufficient living. In such cases, judges may decide simply to award the house to the homemaker. Additionally, the judge may order alimony payments for life and a portion of the pension set aside. Such measures may be deemed equitable under the circumstances.

Be aware, however, that the upkeep of a house and its grounds might be too burdensome and expensive for certain individuals.

What are the tax ramifications when a house is sold pursuant to a divorce?

Generally speaking, property transfers between spouses during marriage or incident to divorce aren't taxable. However, the tax effects on the sale or transfer of your home incident to divorce can vary substantially, depending on whether you (as a couple) decide to keep the house, sell it to a third-party, or transfer it to one spouse with a view toward a future sale.

Transfer to one spouse incident to divorce

Neither spouse recognizes gain or loss if you transfer the title of the home to your spouse incident to a divorce. A transfer of property is viewed as incident to a divorce if the transfer occurs within one year after the date on which the marriage ends or if the transfer is related to the ending of the marriage. Any transfer of property between spouses that is made pursuant to a divorce or separation instrument and occurs within six years after the date the marriage ceases is presumed to be related to the cessation of the marriage.


The spouse receiving the property takes the basis of the transferring spouse and ends up with the combined basis. This result occurs even if the spouse who retains the residence pays cash or other assets in return for the house and the transaction is basically a sale.

Example(s): Assume Mary and John own a home that is presently worth $170,000. Mary sells her half-ownership of their home to her spouse, John, for $85,000 as part of their divorce settlement. Because the property had initially been purchased for $80,000, Mary's basis was $40,000, and John's was $40,000. Mary does not recognize any gain on the sale to John because the sale was incident to their divorce. John's basis in the property will be $80,000.

Delayed sale of house

The parties might decide (in their divorce agreement) that the house shall be sold at some point in the future. Typically, only one spouse remains in the house, but the other spouse continues to be listed on the deed as a joint owner. This raises a question concerning exclusion of the capital gain when the house is later sold.

In general, the law states that if all requirements are met, a taxpayer of any age can exclude from federal income tax up to $250,000 of gain (up to $500,000 for joint filers meeting certain conditions) from the sale of a home owned and used by the taxpayer as a principal residence for at least two of the five years before the sale. Generally, an individual (or either spouse in a married couple) can use this exemption only once every two years.

At first glance, this law would seem to preclude the spouse who moved away (and has lived elsewhere for several years) from claiming the exclusion. However, under the following circumstances, a separated or divorced taxpayer can "tack on" someone else's ownership and/or use period to his or her own ownership and/or use period:

  • An individual is treated as using a home as his or her principal residence during any period of ownership that the individual's spouse or former spouse is granted use of the property under a divorce or separation instrument
  • An individual who receives a home in a tax-free transfer from one spouse to another may tack on the transferor's ownership period to his or her own ownership period

Example(s): Assume John and Mary are divorcing. They agree that Mary can continue living in the house until their daughter, Jane, turns 18 in eight years. At that time, the house will be sold and the proceeds split between John and Mary. In such a case, John will be eligible for the $250,000 capital gains exclusion--even though he didn't reside in the family home for two of the past five years--since he met one of the exceptions.

In addition, even if you don't meet the two-out-of-five-years test or the one-exemption-every-two-years test, you may qualify for a partial exemption. You may claim a partial homesale exemption if the primary reason for selling your principal residence is a change in place of employment, for health reasons, or for certain other unforeseen circumstances. Regulations issued by the IRS specifically list divorce or legal separation as an unforeseen circumstance.

Sale of house to third party immediately

Often, a house will be sold to a third party as part of a divorce settlement and the proceeds split between the spouses. In such a case, if the capital gain exclusion did not apply, the husband and wife would each recognize his or her proportionate share of the gain on the sale (based on the division of the sales proceeds). But this will not be the case if the husband and wife qualify for the capital gain exclusion mentioned above.

Example(s): Assume Mary and John are seeking a divorce. During the course of their marriage, they purchased a house for $100,000 and there have been no adjustments to Mary and John's basis in their home. The house is now worth $200,000, and the couple decides to sell it through a real estate broker and split the proceeds evenly. If their net proceeds from the sale amount to $186,000, John and Mary will each experience a $43,000 gain. Assuming they qualify for the capital gains exclusion, however, Mary and John can each exclude up to $250,000 of gain from the sale of the home.

Tip: When structuring divorce settlements, the timing of property sales and the tax ramifications should always be considered, along with the domestic relations law (i.e., community property states versus equitable distribution states). It is wise, therefore, to consult with a divorce and/or tax attorney even if the property settlement appears to be a simple and amicable one.




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