Considering Tax Implications During Asset Division in Divorce

Dividing your property and debts in a divorce is a complex task, in most cases. In Arizona, most of the assets and debts you accrue during a marriage are considered part of your community property as a couple. Once you have determined what is included in the community property, Arizona law requires that it be divided equitably, which essentially means “fairly.”

One thing that can get in the way of a truly equitable division is taxes. Many of your largest assets may potentially be taxed upon division. Those assets that are taxed at higher rates are, in essence, worth less than others that are taxed at lower rates.

How Do I Find out the Specific Tax Implications in My Case?

Your divorce attorney will have a significant understanding of the tax implications of dividing certain assets. In more complex cases, you may wish to bring in a financial advisor or certified financial planner.

Do your own homework, too. Working with the right team, you can get through the technical stuff.

Here’s a rundown of a few of the most common tax issues arising from property division:

Capital Gains

If you have valuable assets like stock, you generally pay taxes on your profits. The profit, in most cases, is the difference between the amount you paid (the “cost basis”) and the sale price.

That means that a stock worth $100 that you bought at $50 is worth more than another one worth $100 that you bought at $25. When you sell, them, you’ll pay more taxes on the second stock with the lower cost basis.

When dividing assets that could be taxed, consider calculating their projected value after a sale. This “discounted” value can then be divided.

Retirement Savings

Many retirement savings accounts, like 401(k)s, 403(b)s and IRAs, are tax-advantaged. If you take the money out before you reach retirement age (59 1/2), you owe taxes and penalties. These taxes and penalties could significantly reduce the value of the account.

You may need to divide these accounts as part of your divorce. When you do, you may need to make a trustee-to-trustee transfer and/or have a qualified domestic relations order (QDRO) signed by the court.

What you should not do is take the money out yourself and transfer it directly to your divorcing spouse. This will trigger the taxes and penalties.

The Family Home

There are a number of options for dividing real estate in divorce. You could sell it outright and split the proceeds. One spouse could live there while both still own the home. Or, one spouse could buy out the other.

If you will be selling the home, be aware that there could be capital gains on the increase in value of the home since you bought it. However, there is a $250,000 per-person exclusion to those capital gains taxes — $500,000 for a married couple.

If the profit you’ll make on the home exceeds that exclusion amount, you could owe capital gains taxes on the excess. That means the divisible value of the house could be lower than you expect.

It also may affect your decision on when to sell. If you sell before the divorce is final, the $500,000 tax exclusion applies. If you sell after, you only get the $250,000 tax exclusion.

There are many assets that could be taxed upon division. Work with your divorce attorney to identify them and learn how the taxation could affect the value of the asset. Only then can you achieve a truly fair division.