789 / Do transfers of property between spouses, or between former spouses incident to a divorce, result in taxable gains and losses?

Property transferred between spouses or former spouses incident to a divorce generally will not result in recognition of gain or loss (unless the transfer is by trust, under certain circumstances, or pursuant to an instrument in effect on or before July 18, 1984, and the spouses or former spouses have not elected otherwise).¹ The property transferred will be treated as if it were acquired by gift, and the transferor’s basis in the property will be carried over to the transferee, whether the fair market value of the property is more or less than the transferor’s basis.² Ordinarily, if the fair market value of property transferred as a gift is less than the donor’s basis, the fair market value is the donee’s basis for determining loss (see Q 692).

This nonrecognition rule means that the transfer of property between divorcing spouses in exchange for the release of marital claims generally will not result in a gain or loss to the transferor spouse. A transfer is considered made “incident to a divorce” if it is made within one year after the date the marriage ceases, or if the transfer is related to the cessation of the marriage.³ A transfer is related to the cessation of a marriage if: (1) the transfer is pursuant to a divorce or separation instrument; and (2) the transfer occurs not more than six years after the date on which the marriage ceases.

Transfers not meeting the above two requirements are presumed not to be related to the cessation of a marriage, but taxpayers may overcome this presumption by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. Taxpayers may show this by establishing that certain factors, such as legal impediments, hampered an earlier transfer of the property, provided that the transfer occurs promptly after any cause for the delay is resolved.⁴ For example,
a transfer of a business interest between former spouses that did not occur within six years of their divorce was considered incident to divorce since there existed a legal dispute between the former spouses concerning the value of the property and the terms of payment.⁵ See also Young v. Commissioner,⁶ in which a transfer within four years of the divorce was considered to have been made “incident to divorce,” thus making all gain on the transaction taxable to the transferee spouse.⁷

While the nonrecognition rule shields from recognition gain that would ordinarily be recognized on a sale or exchange of property, it does not shield from recognition interest income that is ordinarily recognized upon the assignment of that property to another taxpayer. Where a taxpayer transferred Series E and EE bonds to his spouse pursuant to a divorce settlement, the IRS determined that he must include as income the unrecognized interest accrued from the date of original issuance to the date of transfer. This income does not constitute gain, for purposes of the nonrecognition rule, but rather is interest income subject to the general rule that deferred, accrued interest on United States savings bonds be included as income in the year of transfer. The spouse’s basis in the bonds became the amount of the taxpayer’s basis plus the amount of deferred, accrued interest recognized by him upon transfer.⁸