What is the tax basis for property transferred under IRC 1041?
/What is the tax basis for property transferred under IRC 1041?
Experienced Bay Area family law attorneys will tell their clients about property transferred under IRC 1041.
Property transferred under § 1041 use a carryover basis. This means that the transfer of property is treated similarly to a gift (for income tax purposes only) from one spouse to the other.
“Basis” is the net capital investment in a property. To calculate basis, you need to find the original cost or capital investment. For example, if you purchase a family home in 2011 for $1,300,000, the basis would be $1,300,000. Next, you add the cost of capital improvements and depreciation. In some cases, you are also allowed to add income that passed through the asset and to deduct or subtract the losses. From this number you get the “adjusted basis.”
When it comes to taxation of these assets, the value used for taxation purposes (gain/loss) Is determined by subtracting the “adjusted basis” from the net amount at a sale.
In a divorce situation, parties divide property based on their current fair market values. If one spouse trades the property for another asset, they will be receiving the asset with a basis equal to the original community investment in the property and will pay taxes based on the original community investment when the asset is sold.
In negotiation over marital assets, experienced attorneys will help their clients understand that some assets are more valuable when they are looked at on an after – tax basis compared to when they are viewed on a pre-tax basis.
Remember tax basis is not the same as debt.
It’s important to keep in mind that an asset with a low basis is usually worth less in the final settlement because of its higher tax burden. Additionally, unless taxes are “immediate and specific”, a Court may not consider the impact of tax basis of assets when dividing them.
This means that it is possible to have a division of assets which is equal according to net market value, but which is unequal when the taxes are taken into account.
For instance, consider two assets, Hawaii Rental Property and Tahoe Ski Chalet, each worth $1,000,000 but the Hawaii Rental Property has a basis of $200,000 and the Tahoe Ski Chalet has a basis of $900,000k. If Wife gets the Tahoe Ski Chalet and Husband gets Hawaii Rental Property, the division is equal as far as the Court is concerned because each spouse received property worth $1,000,000.
However, if you look at the tax ramifications of an immediate sale, wife’s taxable gain would be $100,000 (her basis is $900,000), while husband’s gain would be $800,000 (his basis is $200,000). Wife taking the Tahoe Ski Chalet means that she ends up with the better deal and more cash. In this case, the Husband should determine if requiring the assets sold prior to division is a better strategy so that taxes can be taken into account in the overall property division
It should be noted that §1041 also applies to property that is under-water or valued at a loss. For example, if your real estate is worth $1,400,000 but has a basis of $2,000,000, the spouse who receives the property will get the tax benefit of a built in loss. If you have Estate Planning documents in place, it’s important to note that the non-recognition treatment does not apply to negative basis property which has been transferred into an irrevocable trust, even if pursuant to a divorce.
The information set forth in this Question and Answer was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding United States federal tax penalties that may be imposed on the taxpayer. The information was written to support the promotion or marketing of the matters addressed in this Question and Answer. All taxpayers should seek advice based upon the taxpayer’s particular circumstances from an independent tax advisor. The foregoing language is intended to satisfy the requirements under the regulations in Section 10.35 of Circular 230.
If you are interested in learning more, you can contact me at Amanda@gordonfamilylaw.com for more information.