Relentless Representation For Your Family Law Challenges

Planning for future income tax on divorce asset transfers

On Behalf of | Jan 30, 2023 | Divorce |

The divorce process for high-net-worth Maryland couples requires the division of often complex marital assets. On top of working through who gets what, you and your tax adviser should examine future tax consequences of asset transfers related to the divorce.

No immediate tax on asset transfers

The law allows for two people to divide their marital assets without being taxed as if they have newly acquired them. The Internal Revenue Code does not recognize the gain or loss as long as the transfer occurred as part of a divorce settlement.

To avoid having a transfer labeled as taxable, you need to structure the property division carefully to ensure that the exchanges between the spouses are associated with the divorce. Because ownership of some assets cannot be easily or quickly transferred, you have up to six years to complete the transfers without incurring an immediate tax bill. Shares in closely held private businesses represent an example of an asset that you may need years to transfer.

Future tax consequences

Although receiving an asset as part of the divorce does not count as taxable income, you must consider the future taxes owed on an income-producing asset. For example, to limit exposure to short-term capital gains that are taxed as normal income, your tax adviser may recommend that you hold the newly acquired asset for one year if you would be in a lower tax bracket than the person who transfers the asset.

This strategy works to reduce the tax load by preventing the person in the higher tax bracket from liquidating the asset prior to the divorce and paying taxes on it before transferring it to the ex-spouse. Upon receipt of the asset, the recipient can sell the asset later and only pay the lower long-term capital gains tax.