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Tax Consequences of Home Buyout in Divorce
Usually, the main asset being dealt with is the family home. It’s emotional for sure, lots of memories linger that act as anchors that make it so hard to let go and move on. Letting go of loved ones or loved items is always the hardest thing one does in life. Yet, until you do, it remains a bitter minefield between couples in divorce. Sometimes, one simply has to cut and leave the area in order to regroup over time. Living in the past is a dangerous thing psychologically.
The two most common solutions with the family home are selling the house and splitting the proceeds and everyone moves on, or, one spouse buys out the other spouse, the title is converted and that is it. Whether the house is sold and proceeds split per an agreement or there is a buyout, what are the tax consequences?
The Federal Code Section you need to read is Internal Revenue Code section 1041, just like a CPA would. This section regulates what happens when the home is sold or there is a buyout. For instance, in a buyout from one spouse of $90,000 for their share of a home based on mortgage payments they shared for a number of years. The spouse receiving the $90K is not subject to any tax consequences, why? Is it considered income? Capital gains?
I.R.C. § 1041 "provides that no gain or loss is recognized on a transfer of property from a spouse or a former spouse to a spouse or former spouse if the transfer is incident to a divorce".
What this means is that the IRS sees this has property division due to a divorce with a dissolution agreement and filed with the court. It is NOT income.The amount of the buyout can be anything both agree to. But, tax wise, it is not reportable because it is considered property not income from a sale. One could say it is a “gift”.
For example, a husband and wife enter into a property settlement where the wife is to transfer to her husband her one-half interest in the home. Their tax basis is $100,000, and the fair market value of the house is $200,000. If the husband pays his wife cash equal to one half of the fair market value, $100,000, such payment has no tax consequences. The transaction is deemed a gift by one to the other. Any liens would stay with the husband who now owns the home 100%.
IRC 1041 applies to losses and gains. It applies if the fair market value of the real estate property transferred is less than its tax basis. In this case, the seller does not get to deduct a loss in tax returns, but the other spouse gains the loss (as a gift) and can claim whatever the loss is. This issue usually does not occur because most homes have a market value higher than the tax basis for the property.
Incident to Divorce (as a result of a divorce)
IRC sec. 1041 states: " That a transfer is incident to a divorce if it occurs no more than one year after the date on which the marriage ceases, or, the transfer is related to the end of the marriage. If it occurs one year after the divorce, a transfer of property is presumed to be non-divorce related. The transfer must be done by a separate judgement or a written agreement part of a judgement."
The short answer is that in a buyout of a spouse’s share of a home is not taxable as it is not income, but property.