Hopefully you’ve seen our recent blog posts related to the tax aspects of divorce. As a bit of a break this summer, I thought I would share thoughts from the IRS on How a Summer Wedding Can Affect Your Taxes, from their website.
The article touches on some of the basic changes that affect a taxpayer’s return. If the article applies to you, congratulations and best wishes for a lifetime together.
For more information regarding Aronson’s Financial Advisory Services Practice, and the forensic accounting and litigation support services we provide, click here or call Sal Ambrosino at 301.231.6272.
Pat and Jordan were married and lived in the same jointly owned home for 9 years. After their divorce, Jordan lived in the home with their three children. Now, seven years after the divorce, Jordan is selling the house and both parties are asking their respective CPAs how much of the gain may be excluded from their returns. As the professor in my corporate tax class used to say – there is an answer to every tax question: it depends.
In this sad case, these good people still cared about each other and their kids, and had what might be described as a very amicable divorce. They agreed on how the property would be divided and that Jordan would continue to live with the kids in the family home. They decided there was no need to spend gobs of money for professional fees and that their mutual understanding and cooperation would cover most situations that arose. As a result, the divorce agreement, which they signed and gave to the court was very informal and silent as to the disposition of the marital home. As far as they were concerned, this was no problem. They continued to share ownership and both contributed to the mortgage and property taxes. Jordan paid for most of the maintenance and upkeep.
What did the CPAs say about the exclusions?
As a condition for claiming the full exclusion on the sale of a principal residence a taxpayer must have, among other things, owned the property and used that property as a principal residence for at least two of the last five years. While Pat continued to own the property after the divorce, only Jordan used the property as a principal residence.
Because the divorce instrument was silent with regard to Jordan’s continued use of the marital residence, at the time of sale Jordan may claim the $250,000 but Pat gets no benefit of an exclusion and must report the entire gain. Pat no longer was eligible for the exclusion since Pat didn’t reside in the home for at least two of the past five years prior to sale.
Was there a way Pat could have also excluded $250,000 of the gain?
Yes! Special rules covering the sale of a principal residence in divorce provide that a taxpayer is treated as using the property as the taxpayer’s principal residence for any period the taxpayer has an ownership interest in the property, and the taxpayer’s former spouse is granted use of the property under a divorce or separation instrument, provided the former spouse uses the property as a principal residence. Simply by stipulating in the divorce instrument that Jordan was granted use of the property for a number of years or until some event related to the children (e.g., graduating high school, turning 18, etc.) Pat would have also been able to exclude $250,000 on an individual tax return in the year of sale.
Could the result have been even better?
Yes, again! If Jordan had been married to longtime partner Taylor for two of the five years prior to the sale, then they would have been eligible to claim a $500,000 exclusion for the sale on their joint return, while Pat would still be eligible for the $250,000 exclusion on a single taxpayer’s return.
For more information regarding Aronson’s Financial Advisory Services Practice and the forensic accounting and litigation support services we provide click here or call Sal Ambrosino at 301.231.6272.
Sound familiar? The payments in post-separation Years One, Two, and Three were made according to the separation agreement; they were made in cash to the former spouse. The agreement indicated that the payments were alimony and the parties expected that they would be deductible by the payor and taxed to the recipient. The CPA preparing the payor’s tax returns for Year Three just called to say that $35,000 of the payments made in Year Two will be recaptured in Year Three as income.
How did this happen?
As required by the separation agreement, the recipient received $100,000 per year in the first and second years, respectively. In the third year, the recipient received a total of $50,000. There was no child support.
Unfortunately, the answer is an easy one. The Internal Revenue Code calls for alimony recapture if, within the first three post-separation years, payments in years two or three have decreased by more than $15,000 from the prior year. Recapture is calculated and recognized, if necessary, in the third post-separation year. The calculation is purely mathematical.
In this case:
Year 1 payments $ 100,000
Year 2 payments (100,000)
Difference $ -0-
Year 2 payments $ 100,000
Year 3 payments (50,000)
Permitted variance (15,000)
Alimony subject to recapture $ 35,000
The $35,000 deducted in Year Two as alimony must now be reported as income on the payor’s return in Year Three. Sadly, this could have been avoided with proper planning.
For more information regarding the forensic litigation support and valuation services provided by Aronson’s Financial Advisory Services Group, or for questions and assistance related to divorce click here or call Sal Ambrosino at 301.231.6272.