Navigating the Tax Maze of Gray Divorce: What You Need to Know
Divorce settlements are generally not taxable events, according to IRS Revenue Code 1041(a), meaning that the division of marital property doesn’t trigger immediate tax liabilities. However, transferring property is different than selling property, and spouses may need to sell assets after divorce to raise cash, which can have tax implications. It’s important to understand the cost basis of each asset when dividing marital property, as assets with a low basis can result in significant capital gains taxes, reducing the overall value of the settlement. Many attorneys fail to consider tax-loss carry-forwards, which can be used to offset capital gains in the future and have value on the marital balance sheet.
When the marital home is sold as part of the divorce, both spouses may be eligible for the primary residence exclusion of up to $250,000 in capital gains ($500,000 if filing jointly) if they meet certain requirements. It’s important to time the sale before the divorce is finalized or both spouses move out to maximize this exclusion, as investment properties do not qualify for this exemption. Retirement accounts are often significant marital assets, and dividing them incorrectly can trigger taxes and penalties. A qualified domestic relations order (QDRO) is required to divide certain retirement accounts without incurring taxes or early-withdrawal penalties.
Your tax filing status for the year is determined by your marital status on December 31, so carefully planning the timing of the divorce can help you take advantage of the most beneficial filing status. Consulting with tax professionals, divorce financial planners, and divorce attorneys can help you navigate the tax implications of divorce, structure settlements to maximize tax benefits, and prepare for post-divorce tax obligations. While hiring advisers adds to the upfront cost, their guidance can save significant amounts in taxes and financial stress in the long run. It’s crucial to work with a team of professionals to ensure that your finances are handled in the most tax-efficient manner during a gray divorce.