Asset division is a part of every divorce. How assets are divvied up depends on both state and federal laws. For couples going through a divorce in New York, family courts use what is called equitable distribution to divide marital assets and liabilities. “Equitable” is what the court rules as fair, not always an exact split of 50-50.
Federal tax rules apply to divorce settlements. For future ex-spouses, the IRS allows most asset division to take place without adding the hardship of any transfer taxes. However, by accepting an asset through a divorce settlement, the recipient also takes on the tax maintenance — potential tax losses or gains over a certain time period — of that asset.
As long as most assets are divided according to a court agreement, most transfers remain tax-free. The transfers may take place before a final settlement or, in some instances, up to six years after a divorce, as long as the ex-couple sticks by court rules.
For ex-spouses who receive a valuable asset as part of the settlement, the IRS sends a strong reminder that any gains on assets are taxable when sold, unless the gains are offset by tax exclusions. A big profit on an asset will come with an equally sizeable tax bill that some legal experts say can be avoided by negotiating for lesser assets of concrete worth, much like cash.
One exception to the tax-free transfer rule is a retirement account. Shifting any part or all of an IRA or 401(k) to an ex can be a detailed and complex process that comes with a tax burden.
Having an attorney who understands financial divorce and tax fallout could be beneficial if you are going through a divorce. There may be ways to avoid some tax repercussions during asset division.
Source: SmartMoney, “What Divorce Means For Your Taxes,” Bill Bischoff, 8 June 2011