Normally when property is transferred to a spouse, or to a trust in benefit of a spouse, no gain or loss is recognized for U.S. federal income tax purposes.  This is true even if the transfer is made in exchange for cash or for other consideration.  This tax treatment applies to transfers of real and personal property, tangible and intangible property, and separate or community property.

But there are certain cases when property transfers between spouses may not qualify for the  non-recognition of gain or loss for tax purposes.  One of these cases is when your spouse or former spouse is a non-resident alien.

Property Transfers Incident to a Divorce

The non-recognition of gains and losses also applies to property transfers that are incident to a divorce.  A property transfer is considered incident to a divorce if it is made within one year after the marriage ends, or is related to the ending of marriage.  In order to be considered as related to the ending of a marriage, the property transfer must be made under the original or modified divorce or separation instrument, and the transfer must occur within 6 years after the date the marriage ends.

Transfers in Trust

Generally, gain or loss is not recognized on transfers of property you make in trust for the benefit of your spouse or former spouse.  But if you transfer property subject to a liability, and the trust assumes the liability, you have to recognize a gain for  the amount by which the liabilities assumed by the trust exceed your adjusted basis in the property.

For example, if you transfer property to a trust in benefit of your former spouse, that has an adjusted basis of $22,000 to you and has an outstanding mortgage balance of $25,000, you have to recognize a gain of $3,000.

Transfers to Third Parties

When a transfer is made to a third party on behalf of your spouse or former spouse it is treated as two separate transfers.  The first is considered to be a transfer from you to your spouse or former spouse, and the second is a transfer from your spouse or former spouse to the third party. You do not recognize any gain or loss on the first deemed transfer, but your spouse or former spouse may have to recognize gain or loss on the second deemed transfer.

This treatment applies when:

1. The transfer of property to a third party is required by your divorce or separation instrument.
2. Your spouse or former spouse gives you a written request to transfer the property to a third party.
3. Your spouse or former spouse consents to the transfer in writing.  This written consent must indicate the intention of both of you to treat the transfer as being subject to section 1041 of the Internal Revenue Code.

Basis of Property Received by a Spouse

For property you received from your spouse after July 18, 1984, under a divorce or separation instrument in effect on that date, and for property transferred after 1983, under which you and your spouse elected to treat the transfer under section 1041 of the Internal Revenue Code, the adjusted basis to the spouse who receives the property is the same as the adjusted basis of the spouse giving up the property.  This is the case regardless of the property’s fair market value at the transfer date and regardless of any consideration you paid for the property.  This is the basis that is used to determine whether you have a gain or loss if you subsequently sell or dispose of the property. 

For property you received on or before July 18, 1984 in settlement of marital support rights, your adjusted basis is the property’s fair market value on the date you received it, unless you made the section 1041 election.

For example:

• If a house was jointly owned and under a divorce instrument in effect after July 18, 1984, one spouse’s interest in the house was transferred to the other spouse, the adjusted basis in the house for the receiving spouse will be the combined adjusted basis before the divorce.
• If the house was jointly owned and half the interest in the house was transferred under a divorce settlement on or before July 18, 1984, the adjusted basis for the receiving spouse will be his or her adjusted basis in one half of the house plus one half the fair market value of the house on the date of the transfer.

Reporting Income From Property

Income may have to be reported on certain property transfers to a spouse or former spouse:

• When income-producing property is transferred, the spouse who transfers the property must report the income up until the date of transfer, and the spouse who receives the property must report income after the transfer.  This property includes an interest in a business, rental property, stocks and bonds.
• When an interest in a passive activity is transferred, there may be unused passive activity losses that have not been deducted for income tax purposes due to the limitation on passive activity losses.  A passive activity for tax purposes is a trade or business in which you do not materially participate, or a rental activity, even if you do materially participate, unless you are a real estate professional.  In this case, the spouse who transfers the interest cannot claim the unused passive activity losses, and these unused losses are added to the adjusted basis of the property for the receiving spouse.
• If property on which an investment credit has been taken is transferred, and there is a possibility that part of the investment tax credit may have to be recaptured if the property is sold or disposed of, the spouse who transfers the property does not have to recapture any part of the credit, and the receiving spouse may have to recapture part of the credit if he or she sells or disposes of the property or changes its use during the recapture period.
• If non-statutory stock options (options not qualified for special tax treatment) are transferred, the spouse who transfers them does not have to report any income, and the receiving spouse has to report income when he or she exercises the option.
• If non-qualified deferred compensation is transferred, the spouse who transfers it does not have to include it in income, and the receiving spouse must include it in income when it is paid or made available to him or her.

Gift Tax on Property Settlements

The federal gift tax does not normally apply to property transfers between spouses or former spouses, because these transfers usually qualify for an exception from the gift tax. These exceptions include:

• Transfers made in settlement of marital support rights, to the extent the value of the property transferred is not more than the value of the rights.
• Transfers that qualify for the marital deduction.  Transfers made to a spouse before receiving a final decree of divorce or separate maintenance are not subject to gift tax, unless the transfers are terminable interests or the receiving spouse is not a U.S. citizen.
• Property transfers under a divorce decree.
• Transfers that are made under a written agreement to settle marital rights or to provide a reasonable child support allowance, if you divorced during the 3-year period beginning one year before, and ending two years after the date of the agreement.
• Property transfers that qualify for the annual exclusion from federal gift tax.  The first $11,000 of property transfers of present interests per person can be excluded.  A present interest exists if the receiving spouse has unrestricted rights to immediately possess, use, and enjoy the property and any income the property generates.

If a property transfer between spouses or former spouses does not qualify for any of the exceptions, it must be reported on Form 709, United States Gift Tax Return.

Qualified Domestic Relations Order

Certain property rights or ownership may be transferred through a qualified domestic relations order (QDRO). A QDRO may involve paying benefits from a pension or profit-sharing plan to someone other than the participant; paying child support, alimony, or marital property rights; or it may specify the amount or portion of a participant’s benefits that must be paid to the participant’s spouse, former spouse, or dependents.

How the benefits of a particular plan are taxed will depend on whether, under the QDRO, the benefits are paid to the plan participant’s child or dependent, or to the participant’s spouse or former spouse.

• If the benefits are paid to the participant’s child or dependent under a QDRO, they  are treated as having been paid to the participant and are subject to the tax rules that would apply for the participant.
• If the benefits are paid to the participant’s spouse or former spouse, the benefits generally must be included in the spouse’s or former spouse’s income for tax purposes.  If the participant has an investment in the plan, this cost may be prorated and assigned to the receiving spouse or former spouse in order to determine the taxable amount of the benefits.  If benefits are paid in a lump sum distribution, the spouse or former spouse can use the special tax rules on lump sum distributions, as if the distribution had been made to the plan participant.  Eligible rollover distributions received by a spouse or former spouse under a QDRO may be rolled over tax-free into a qualified IRA or other qualified retirement plan.

Individual Retirement Arrangements and Health Accounts

If all or part of your traditional IRA is transferred to your spouse or former spouse as a result of a divorce, the transfer is not a taxable transfer.  Starting from the date of the transfer, the IRA is considered to be your spouse’s or former spouse’s IRA.

The same is true for transfers of Health Savings Accounts (HSAs) and Archer Medical Savings Accounts (MSAs).