Tax Efficient Gifting of Home Equity in Divorce

Assets acquired in a divorce do not normally trigger any tax at all. The wrong way to do divorce (IMO) is for one spouse to cash out a position and then give the proceeds to the other spouse--that will trigger taxes for the original owner. You cannot claim a deduction for home mortgage/property taxes unless you owned an interest in the home and you made the payment(s).

Is that what you are telling her, or what she thinks? Either way, that's a pretty limited and unrealistic view of her financial universe.

But an alimony deduction (adjustment) is better than a qualified home mortgage interest deduction, because it reduces AGI and isn't subject to any limitations.

I'd recommend as a first step to sort out what is child support, what is alimony, and what is a property transfer. Pub 504 is a good place to start. Community property issues, if applicable, will further complicate matters and vary from state to state.

-Mark Bole

And be sure this "alimony" meets the definition of alimony. Even if it does, if payments decrease or stop during the first three years, you maybe subject to Alimony Recapture.

financially

That's what she is telling me, but her expenses per month are $9K and she makes $3K per month. Does it take a PhD and $4K in consulting fees to realize there is a gap between the two? No matter how this ends up she needs to make a LOT more and spend a LOT less.

If he pays her alimony to cover a home mortgage payment, then I guess he needs to size that payment so that the amount she receives post-tax covers the payment? And if she owns the home in full now she will claim the home mortgage interest deduction?

The husband will reduce his income dollar-for-dollar even if he is well into AMT? Let's say the home mortgage payment is $4K / month and the husband is in the 35% marginal tax bracket. His state income tax in California is

10%. So $7200 of income pays the $4K mortgage with after-tax money. The husband has to pay $7200 to the wife in alimony - assuming she gets more income and her tax bracket stays at 35% - so that she can make the $4K payment with after-tax money. At the end of this the husband comes out the same in net pay as if he were to pay the $4K mortgage directly?

If the husband pays the home mortgage directly, and instead continues to claim a home mortgage interest credit, does the wife in this case need to count those payments as income as well?

Based on that publication it sounds like some tax efficient things to do are:

- Maximize child support payments since those are not subject to tax

- Transfer ownership of assets before divorce is finalized to avoid taxation on the asset

- Husband should gift the wife $12K per year after the divorce (if things stay amicable obviously) since those funds are tax free to the receiver

The rules in 504 that pertain to reducing child support and converting to alimony and that reference contingencies for child support seem fairly complicated.

Regarding your last paragraph, I thought it was the other way around: alleged alimony that could be considered instead to be child support, under the "wrong" circumstances.

In general, as soon as you say "tax efficient", you have to question, "for whom?" Isn't there a conflict of interest here? Start with something basic, such as, what filing status will be used until the divorce is final, and thereafter?

-Mark Bole

Transfer of property due to divorce is completely income tax exempt. - IRC Section 1041

He has no deduction for interest after the transfer.

All the statute says is "related to the cesssation of the marriage." That doesn't require finality (at the time of transfer). However, transfers must complete before 1 year after the finality.

I did not read the entire 504 publication. I was looking at child support sections in 504 that talked about contingencies that could be used as a reason to stop paying child support.

Well it all looks complicated. On one hand, failure to pay child support has a legal recourse in some states as a crime. Failure to pay alimony is a civil matter, and probably difficult to force a collection.

child support. From the wife's point of view, it's reversed.

So you have to calculate tax issues as well as think long term about what is most likely to continue to be paid.

I assume the easiest thing to do is to file 2009 as normal, complete divorce in 2010, and file 2010 as two single returns? (Wife may be head of household because of child.)

On Sep 1, 10:31 am, "Gene E. Utterback, EA, RFC, ABA"

If he doesn't transfer the house, it seems he can still deduct his half of the mortgage payment and half or all of the property tax (depending on how the property is owned) on his Schedule A. If he pays the wife's half as well, he deducts these as alimony, and his wife includes them as alimony, but I guess his wife gets to deduct these on her Schedule A. See Table 5 in publication 504.

In addition, section IRC 121 (d)(3)(B) seems to allow the husband to claim the section 121 exclusion even if he doesn't actually live in the house.

A 12k alimony payment disguised as a gift is still alimony.

Why is the basis 100k? Since wife paid FMV of husband's half, I would imagine cost basis would be her original cost basis plus the FMV she paid for his half, total of 300k. This would certainly be the case if there were two separate houses, say one in Chicago and one in Seattle, both 50k at the start, both now 250k.

Why is this? H's gain is 250k-50k 0k. Assuming the rules of section 121 are not met -- say he lived in the house 1 year only and does not meet any of the special rules -- then this 200k should be fully taxable as a capital gain.

Since the interest on the mortgage is deductible, the number $7200 may be too much. Suppose all $4000 is mortgage interest, then it is fully deductible. And if your other deductions are >= the standard deduction, the $4000 is really fully deductible, so you need only 4k of after-tax money to pay the mortgage.

This, and everything else except the below quoted section I agree with.

WRONG! As noted in the statute (quoted earlier in the thread), the period is ONE year. Six years is too long. - IRC 1041(c)(1).

Because the law says so.

Gene E. Utterback, EA, RFC, ABA

While we all do it save bandwidth, I hate it when messages get snipped - makes it hard for me to follow and I sometimes end up putting my foot in my mouth - with that little accouncment . . .

I'm not sure the husband can deduct the mortgage interest if he isn't living there. To deduct the mortgage interest you have to meet two tests -

1 - you have to have a legal obligation to pay; 2 - it has to be your primary or secondary home.

H may meet test 1 - his name is still on the note.

But how can he meet test 2?

Gene E. Utterback, EA, RFC, ABA

Code Section 1041 does say that a transfer of property is incident to divorce if it occurs within one year after the date on which the marriage ceases or is related to the cessation of the marriage.

However, Treasury Regulation 1.1041-1T(b) goes on to say a transfer is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument and the transfer occurs not more than six years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or amendment to a decree or instrument. Reg. Section 1.1041-1T(b),

Gene E. Utterback, EA, RFC, ABA

On Sep 10, 6:38 pm, "Gene E. Utterback, EA, RFC, ABA"

What the law says is that transfers of property incident to a divorce have no immediate tax impact. No gain or loss is recognized by the person giving up an ownership interest while basis and holding period flow to the new sole owner of the property.

The OP describes a transfer of property incident to a divorce.

Suppose the divorce decree says that ownership of the house is divided equally; subsequently, one party buys out the other's interest (at FMV). Is that purchase a 1041 transfer or an actual sale?

Seth

1041 transfer, no sale, no basis adjustment.

Gene E. Utterback, EA, RFC, ABA

Publication 504 says that if you are required to pay the entire mortgage as part of the divorce agreement, half of the payment is alimony, and half is deductible on your tax return. Search for "Payments for jointly-owned home" in

it looks like you can deduct the mortgage interest even if it isnot your primary or secondary home.

(4) Other definitions and special rules For purposes of this subsection? (A) Qualified residence (i) In general The term ?qualified residence? means? (I) the principal residence (within the meaning of section 121) of the taxpayer, and (II) 1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence (within the meaning of section 280A (d)(1)).

The key thing is "within the meaning of section 121".

And section 121 says the following:

(B) Property used by former spouse pursuant to divorce decree, etc. Solely for purposes of this section, an individual shall be treated as using property as such individual?s principal residence during any period of ownership while such individual?s spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in section 71 (b)(2)).

So it looks like mortgage interest, or half of it, an be deducted by the one making the mortgage payments. What always confuses me though is whether the person who is divorced at does not lived in the house can deduct mortgage payments for three houses -- the former home that he/she lived in as the primary home, their new primary home, their new secondary home.

Which section?

1041 and the related regulations.

I'd also like to point out that while many of us use the IRS publications, they are NOT authoritative in and of themselves. They are information sources of information that CANNOT be relied on as substantiation to defend a position. They are a great source of information and many of them contain very valuable and informative illustrations, but they are NOT the law.

The following quote from Green v. Commissioner, way back in 1969, is pretty clear - "In the first place, even if Your Federal Income Tax were construed to permit deduction of what would otherwise be nondeductible commuting expenses, it is clear that the sources of authoritative law in the tax field are the statute and regulations, and not informal publications such as Your Federal Income Tax. Dixon v. United states, 381 U.S. 68, 73 (1965), Adler v. Commissioner, 330 F.2d 91, 93 (C.A. 9, 1964): Eugene A. Carter, 51 T.e. 932,

935 (1969)." Just an FYI

Gene E. Utterback, EA, RFC, ABA