Claudia and Bert were married more than 30 years before their divorce. At the time of their divorce, their marital estate was worth several million dollars.

Among their assets was the “Happy Valley property” in which they each received a 25 percent separate interest as part of the divorce settlement. The other 50 percent owner was a trust for the benefit of their children and grandchildren.

Purchase Bob Bruss reports online.

As part of the divorce, Claudia received a $500,000 equalizing money judgment from Bert. About 10 months after the divorce was final, the Happy Valley property was sold to a developer.

But shortly before that sale, Bert transferred his 25 percent interest in the property to Claudia, in return for a credit against the $500,000 judgment he owed to her. This transfer to Claudia was tax-free, as allowed by Internal Revenue Code 1041 for property transfers to a spouse within 12 months after the divorce.

Claudia then signed a deed selling her 50 percent interest in the property to the developer. On his income tax return, Bert reported a gain on the sale of his 25 percent interest in the property.

However, upon audit by the IRS, Claudia was found to owe a capital gain tax on her 50 percent property sale. The IRS reasoned Claudia conveyed a 50 percent interest to the developer, not just 25 percent, as she argued. She took her dispute to U.S. Tax Court.

If you were the U.S. Tax Court judge would you require Claudia to pay capital gains tax on the sale of a 50 percent interest in the property to the developer?

The judge said yes!

Inter-spousal transfers of assets as part of a divorce are tax-free under Internal Revenue Code 1041, the judge began. Therefore, Bert’s transfer of his 25 percent interest in the Happy Valley property to Claudia was tax-free, he explained.

However, Claudia’s subsequent sale of the land to the developer was not part of the divorce settlement, the judge continued. It was a business transfer after the divorce, he noted.

“No effect can be given to an agreement between Claudia and Bert as to how the gain on the sale of her interest in the Happy Valley property was going to be reported on her income tax returns,” the judge emphasized. Because she failed to pay tax on her entire capital gain from the land sale to the developer, Claudia owes $42,053 deficiency tax, plus $8,411 negligence penalties, the judge ruled.

Based on the 2003 U.S. Tax Court decision in Walker v. Commissioner, T.C. Memo, 2003-335.

(For more information on Bob Bruss publications, visit his
Real Estate Center


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