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By Ilyce Glink
1/30/2009 8:00:00 AM
Q: This isn't a question, but a comment on a recent column about buying out an ex-spouse. When one spouse purchases the other spouse's interest in a property, the "seller" is deemed to have received a gift and the "buyer" cannot increase the tax basis in the property, according to IRC Section 1041.
This tax issue is seldom addressed in answers to questions from divorcing couples, but I believe that this should be part of every answer to questions about buying out an ex-spouse.
One of my friends purchased his ex-spouse's equity in their home and in two pieces of rental property. He gave her a tax-free cashier's check for $400,000. He received no increased basis for the rentals and had a taxable gain on the sale of the residence several years after the transactions.
A: Thank you for your letter. According to my research, IRC Section 1041 provides that no gains or losses are recognized on property transfers between spouses during marriage, or on property transfers between ex-spouses, as long as that transfer is part of the divorce agreement.
It would be as if one spouse gave his or her interest in the property to the other. The transferee spouse takes on the transferor's cost basis, which is how future profits will be calculated.
According to the IRS, the basis of the property transferred between former spouses is not increased even if there is a cash payment as part of the transfer. This has been confirmed in tax court.
If your friend was upset at giving his spouse $400,000 and later sold the property only to have to pay more taxes than he thought he would, he should have negotiated a different payment arrangement with his now ex-spouse.
When accounting for the value of the property at the time of the spit, the parties should have considered what each of them would pay in taxes if both of them had sold the property. If they had taken into consideration what each of them would have received after the payment of real estate commissions, other transaction costs and federal and state income taxes, the split might have been quite different.
If the spouse who kept the property then sold the property, that spouse effectively then has to pay federal and state income taxes on the other spouse's share.
And I agree, this is an important concept that many divorcing spouses with real property should consider. If you or someone else you know is in this situation, a detailed conversation with an accountant who handles the tax consequences of plenty of investment property transactions is in order.
Q: My mom passed away and left some assets including her IRA valued at $78,000 to my two sisters and me. How much is the IRS likely to tax us? I've heard scary figures like 65 percent. Is there a way to lower that amount?
A: My condolences on the loss of your mother. Unless you take a lump sum distribution at the time you inherit the money, the IRS allows you and your sisters to roll over the IRA into an account known as an inherited IRA. If you rollover the funds into an inherited IRA, you'll have five years to withdraw the funds entirely or you must withdraw funds over time.
When you withdraw the funds, you'll pay income tax on the accounts at your marginal tax rate. So if you are in the 25 percent bracket and have a state tax of 4 percent, you'll pay a total of 29 percent tax on the funds. If you withdraw funds over time -- there's a formula for determining how much money you have to withdraw each year -- you lessen the amount you pay in tax. If you take a lump sum payment, you might bump yourself up into a higher tax bracket and end up paying more.
If your mother also left real estate, like a house, you should be able to inherit it at its value on the day she died, which is known as a stepped-up basis. If you turn around and sell the property for approximately the same value as on the day she died, you should not owe any additional taxes and will be able to keep any profits after paying off any mortgage liens against the property.
If your mother's total estate exceeds $3.5 million, you may have to pay additional taxes. Please consult with your tax preparer or an estate attorney for more details.
Q: My elderly parents have Proctor & Gamble stock and a house that is paid off. We may be faced with putting my father in a nursing home. How can we protect their assets without my mom going bankrupt paying for my father's care? Can she gift the stock to her children?
A: There is a five-year look-back period for Medicaid. If your father goes into a nursing home, and your mother tries to transfer all assets out of the estate so that your father qualifies for state or federal aid, a judge can look for assets that were transferred or sold over the previous five years and possibly reverse the transactions.
The assets your parents have are supposed to be used for their care in their old age.
Your mother should speak with a qualified elder care attorney about what, if anything, can be done to protect her from going bankrupt (which shouldn't be necessary to apply for Medicaid).
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