TRANFERS BETWEEN SPOUSES DURING MARRIAGE
OR INCIDENT TO DIVORCE
Special rules apply to transfers of property, such as sales,
between husbands and wives. In fact, there are special rules
in general treating such transfers as gifts. These rules
apply to transfers between married spouses and apply as
well to transfers between ex-spouses related to their divorce.
This is a “nonrecognition” rule that is non-elective.
That is, where one spouse sells property to another, no
gain or loss on the sale is “recognized” (reported,
for tax purposes), even if the parties would prefer to report
it. Any payment made for the transferred property is ignored
for tax purposes. And the basis (cost) of the property remains
unchanged.
Example: Frank owns land in which his basis is $10,000.
He sells it to his wife Susan for $18,000, its fair market
value. Frank does not report any gain on the sale. Susan
is the new owner, but her basis is $10,000 (Frank's basis),
even though she actually paid $18,000 for it.
Note that the “buying” spouse gets the “selling”
spouse's basis in the property even if it's higher than
the property's value (say the value was just $5,000 in the
above example). In this regard, the spousal transfer rule
differs from the gift rules. With an actual gift (to a nonspouse
donee), if the donor's basis is higher than its value at
the time of the gift, the donee receives a “dual”
basis: the higher figure as basis for purposes of computing
gain and the lower figure for purposes of computing loss.
The spousal transfer rules apply to married couples and
to transfers “incident to divorce.” A transfer
is incident to divorce if made within one year of the end
of the marriage or (even if later) if it relates to the
end (e.g., if the transfer is called for in the divorce
decree but only occurs after a year). Thus, if one spouse
transfers property to the other in settlement of marital
rights, the transferring spouse has no gain or loss on the
transfer and the basis carries over.
The spousal transfer rules discussed above also apply
to transfers to a spouse or former spouse, incident to divorce,
of nonstatutory stock options and/or rights to nonqualified
deferred compensation that an individual has received as
compensation for employment and that haven't yet been reported
as income. The spousal transfer rules make the transfers
themselves nontaxable events and (except where certain pre-November
9, 2002 divorce agreements or divorce-related court orders
provide otherwise), also mean that the transferor isn't
subject to income tax on the income attributable to the
transferred items (although that income is treated as the
transferor's wages for Social Security tax purposes). Instead,
the spouse or former spouse must recognize that income when
he or she exercises the stock options or when the deferred
compensation is paid or made available to him or her.
Exceptions
There are several narrow exceptions to the above rules.
Two of them apply when property is being transferred into
a trust by one spouse for the benefit of the other spouse
(or incident to divorce). First, gain will be recognized
if (and to the extent that) the amount of debt to which
all of the property transferred is subject exceeds the basis
of the property. The second exception is for installment
notes transferred into the trust: gain would be recognized
as if the note were disposed of to an unrelated party. The
last exception applies to U.S. savings bonds, Series E and
EE: if these are transferred to an ex-spouse as part of
a divorce settlement, the transferror must report the interest
that has accrued on the bonds (that hasn't already been
reported).
CHECKLIST OF CHANGES DUE TO THE DIVORCE
