Divorce-101: About Taxes

ASSESSING ASSETS   

Divorce decrees spell out which party gets what were previously joint assets. Such new, single ownership, however, can create some tax issues.  When considering an asset as part of a settlement, don't just look at its dollar value. An asset's tax consequences could make a big difference as to whether you want it as part of the property division. 

For example, a couple decides to split a tax-deferred retirement account and a regular investment account, each worth $100,000. The ex-wife takes the retirement fund; he keeps the other account. But when she starts taking retirement distributions, she's likely to face a large tax bill on the tax-deferred money. He, however, is in much better financial shape because the regular account has been paying taxes incrementally over the years.  A property’s cost basis also could make a tax difference when an asset is sold.  

And don’t forget the house, usually a couple's largest asset. If you sell it as a couple, there is no tax on up to $500,000 in profit. But a single seller only gets half that exclusion amount. If both parties agree to sell the home, the best tax move might be to dispose of it before the divorce is finalized so they can take the larger sale exclusion. 

If one spouse gets sole ownership of the home after the divorce, the reduced exclusion for a single taxpayer could produce a tax bill if the property has appreciated greatly over the years. 

There also are tax issues if both parties, although divorced, retain ownership into the home. To exclude sales profit, you must live in the house as your principal residence for two of the past five years when you sell; for the spouse that moves out, the house must be sold within three years after that departure date. If it's not sold by then, the nonresident spouse could face taxes on any sale profit. 


ACCOUNTING FOR SUPPORT

Alimony is tax-deductible for the person paying. For the recipient, the payments are taxable income. Both parties, therefore, need to keep complete and accurate records to document their payments and receipts. Without sufficient documentation, the payer may lose the alimony tax deduction. And because the recipient's Social Security number will be reported on the paying taxpayer’s return, the recipient must ensure that he or she reports the same amount to the IRS as income. 

Child support is never tax deductible. Neither does it count as income to the custodial parent receiving the payments on behalf of the child.