A (2:51)

Right.

B (2:52)

And it's actually US persons, not really citizens. So, you know, you can be green card holder, et cetera, and you're fine. The basic premise of it is that if you can do unlimited spousal gifting, why are we making them do weird gifting before they divorce? When they're fighting, why not just say, look for a period after you're gonna get divorced. Whole bunch of stuff is tax free. Let's just have one less thing for people who are already fighting, right? Likely if they're getting divorced, they're already fighting. Let's just have one less thing for them to fight over. I think that's a good idea. So the idea is that it's non taxable in the time. It essentially just defers the gain or loss to a future disposition. So you think about any of the, you know, the reorganizations under 368, 1031, exchanges, et cetera, et cetera. It's not really tax free. It's just not no tax then. That's the idea. There can be taxable situations. You know, if you transfer real property between spouses, that can be subject to transfer tax. Those are state taxes. States can decouple from 1041. I don't believe any do, but they could. And that's the idea. The key is not, you know, the key when I think about this, right, people are getting divorces is not just to maximize the fair market value. A lot of people say, oh, I want the piece of property worth a hundred, I want the piece of property worth 200. I don't want the one worth 50. And I always say, well, that's not the best right. You want to maximize the fair market value, the value of the property, piece of property, less the tax that will be due, right? That's the maximization. So you get a tact holding period. You maintain character. Generally capital versus ordinary, though it can change, you know, if one use it in a trade or business, and for another, it's a capital asset. You could have different ones, but you know, the example I always give is two pieces of property, okay? One is worth a hundred and one is worth eighty.

A (4:35)

Right.

B (4:35)

Which one do you want versus I want the one worth a hundred. But my question becomes what? What if the one worth 100 has a $20 basis and the one worth 80 has an $80 basis, right? Well, at basically any tax rate, the one worth 80 is actually more valuable because you can sell it and there's no tax or one's real estate and one's a car. Cars are subject to sales tax when they're sold, generally speaking. So it depends. You're also going to look at, you know, what's the tax rate, right. Capital versus ordinary, is there recapture of depreciation, things like that. Some courts will just entirely ignore, right, the tax consequences when determining the equitable division of assets. So get, get an expert, get someone to come in and look at it. This is a situation where you really, really, really, really, really want to have an expert and have someone who thinks about these things and goes through it. Most divorce attorneys are pretty good. They'll ask questions, things like that. But it depends. And one of the biggest assets that gets split up is the marital house. Right. The home. And if both sell, right. Section 121, you get $25,000 gain each. If one sells to the other, it's not taxable at all. So you can do that tax free, you know, because it's incident to the divorce. Before, you know, I get into more details, I want to kind of pause for a moment. You know, I must note that this is a situation where you should not, you know, let the tax tail wag the dog. This is life. You know, a lot of times there's kids involved, you know, behave like adults. Don't fight over the last penny, just be done with it. Legal fees often eat up, you know, more than the benefit anyway, so I think that's an important thing to think about. So let's talk about section 1041.

A (6:14)

Right?

B (6:14)

It's a fairly technical section, as they often are. And to transfer assets under 1041, section 1041, which means, you know, it's tax free, no tax on the transfer income tax.

A (6:24)

Right.

B (6:24)

You need a divorce or separation instrument. So what is a divorce or separation instrument?

A (6:30)

Right.

B (6:30)

A decree.

A (6:31)

Right.

B (6:32)

It's a judgment decree of separate maintenance. Would also work. State law decree, foreign law decree. So if you get divorced in, you know, France. Right. That qualifies for 1041 purposes, has to be a competent jurisdiction. You know, people always ask me, what if you know, this is a religious court. Maybe, you know, I don't, I don't see a reason why a religious court wouldn't work for a decree. Generally want a government involved. But you know, religious courts can work instrument, incident to a divorce decree.

A (6:57)

Right?

B (6:58)

That also does it. You need writing. Marital settlement terms can be formal or informal. You could write a letter, you know, I'm giving you this, we're done, I hate you, go away. You know, you're mean to me, whatever, that kind of stuff's fine. That's a private instrument. It's incident to divorce, but it's just a letter between the two. And there's also written separation instrument, not legally enforceable, but it contemplates separation. You know, I always say, look, like it's an email where one spouse says, look, I will give you, you know, this and this and this and we're done. It's not, it's not signed, but an email would work. You know, it can be fairly informal, but you don't have to do anything else. So the final option with the decree of support is even if temporary, right? You can just have a decree or you can have agreement that says for the next six months, that's fine, voluntary payments. So if you just said, look, I'm just going to pay you $50,000 a month, $50 a month, $200 a month, whatever. You know, you must intend to qualify for the treatment, even if temporary. But you have to actually intend to qualify. That's the key. And you know, the divorce or separation instrument or an incident, divorce or separation. Look, I'm not going to belabor the point, but it's about intent, right? I keep talking about it. What do you intend to do? And it's inferred by your actions. So if you start paying, you're know, you say, I'm writing you an email, then you do it, then that'll qualify under 1041. It may not necessarily qualify otherwise for legal purposes, but it'll fit into 1041. It's intended to be broad, it's intended to be easy to fall into number two, right. The big thing is alimony versus child support, right? So it used to really matter. It mostly doesn't anymore. But it might still really, really important to sort of how to deal with the pre2019 law and a few other things. So alimony, right? What is the definition of alimony?

A (8:49)

Right.

B (8:50)

A spouse making payments to another spouse. It allowed for shifting income from high to lower brackets and is under Section 71, which has since been Repealed. The law was changed in 2019 under PL 115 97, commonly referred to as the Tax Cuts and Jobs Act. But agreements will stay as alimony. So they'll stay as alimony unless they are modified after 2018. And the agreement says that section 71 repeal applies. So if there's no modification, they are still taxable and deductible. Little quirk there. So a lot of times you have people get together and they say, well, this is what we're doing or not. Sometimes you have, you know, the moneyed spouse who's at the max rates. And this was a way to get a deduction for that spouse and push it into a lower bracket, you know, and that. That's important to think about and that's something that still people can do. So you know, pre2019. Right. The pay or spouse gets a deduction. The payee spouse receiving spouse has ordinary income. Income is not traced. So it's not like it's income from X or Y. And income is it's income when it's constructively received. So you don't actually have to receive it, but you could receive it and it's deduction when actually paid. So you had situations where you may have had income before you had a deduction. That can happen. And I think that's important. Or you could time it out the other way.

A (10:08)

Right.

B (10:08)

You know, put, put a letter in the mail on December 31, doesn't get received till the 3rd, 2nd, 3rd, whatever, 2019. At current, most of my clients have gone through and have updated, you know, to deal with this. So what they basically did is generally no tax, no deduction. Tax law dictates this. Not, not an agreement. So you can't agree to something that is contrary to tax law. Montemoral vs Montmoro, Arizona case that talked about it. There is however, a quirk in the regulations under section 71 which still apply. 1.7116 example 2. If a pre or post nup has language saying that it's alimony and it's taxable, even if It's a post 2018 divorce agreement. But the pre or postnup is pre 2018.

A (10:54)

Right.

B (10:55)

Excuse me. Pre 2019 you still have tax and deduction. Unless. Unless you know, and I think that's important. Unless.

A (11:03)

Right.

B (11:03)

The things I talked about earlier, it was modified after 2018 and agreement says he. This is what we're changing.

A (11:08)

Right.

B (11:09)

So you can, you know, change that however.

A (11:11)

Right.

B (11:12)

Treasury regulation 1.71 dash 1E1T temporary regs Q&A26. It says the opposite thing, right? There are no rulings and cases on point. So you want to think about this in this way, right? Agree on what you're doing, agree and take a consistent tax position. Section 71 was repealed, but that doesn't mean it's not effective anymore. It still kind of exists for agreements from before. So there's a fundamental question as to whether if your pre or post Nup was pre2019, however the divorce was after, is it still alimony and taxable and deductible, or is it not?

A (11:47)

Right.

B (11:48)

And you want to agree on that and take a position. The treasury has not issued regulations. There's no guidance on point. Unclear what the actual answer may be. And so I think it's important, you know, this is one of the situations where you really, really, really want to, you know, agree on whatever's happening because you don't want a situation where one spouse sings one thing and the other one thinks the other or no one's really thought about it.

A (12:08)

Right.

B (12:09)

A couple states have. The couple from section 1041 don't know why you must have actually had to be married. No, you know, palimony, I guess, is the. Is the term. So, you know, you actually have to legally be married. So people laugh when I say that. But you know, there are situations where people have a quote unquote divorce where they get religiously married but never actually legally married under the law, United States of America or another country. And I think that's important. So you can't have alimony without it, can't have child support, can't have other things, but that could be taxable and in different ways. You know, not just payments to the ex spouse can be payments on behalf of the ex spouse. So if one party is paying for both attorneys, if one spouse is paying for housing, things like that, a payment that is fixed and to support a child is presumed to be child support, which is not deductible or income. I'll get on that in a second. And you can have what's called excess alimony. I'm not going to go into what that is because the calculation is extremely mechanical but and largely irrelevant. But the idea behind it is, you know, like, it sounds silly to say, but, you know, some people, they wanted the deduction and so they paid extra alimony. But there is an actual way to do it to have extra excess alimony. It's buried within the section 71 and 1041, how it mechanically works. Child support.

A (13:23)

Right.

B (13:24)

I said it before. Don't disguise child support and call it alimony. Cause if you have too much alimony, it just gets shifted back and it's not really an issue. Right. Because child support isn't taxable. It's not deductible. You know, you should be paying for your kids anyway. Their, their education, their living expenses, you know, to go to camp, to go to the arcade. I don't know, kids still go to the arcades, but that's kind of what's going on there. And then, you know, not really an issue because for the most part, and probably likely going forward, alimony isn't taxable anyway. I never totally understood why it was. I thought it was kind of a quirk and a little weird. And it created a situation where it was a way to pay someone a little more and end up, you know, in a better place because you net tax and the tax rate disparities can really matter. I think that's an important one to sort of think about. So everything, you know, divorce decrees and things now.

A (14:10)

Right.

B (14:11)

Is taxed the same way. Alimony and child support are not taxable and not deductible for the most part. So let's take a quick moment break and we'll be back. So welcome back. We're talking about, you know, property transfers between spouses and former spouses under section 1041. So generally not subject to tax. No income, no deduction, and no gift tax. That's an important thing to point out that, you know, spouses have unlimited gifting, former spouses don't. So this is really to deal with the fact that it sort of, I've always viewed it as, it just extends the gifting.

A (14:46)

Right.

B (14:47)

So if either spouse is a non resident alien.

A (14:50)

Right.

B (14:50)

Non citizen, but a US Person is. Okay, but non res. Non citizen, not a US Person.

A (14:55)

Right.

B (14:56)

If either spouse's tax is a non resident alien, it's taxable. There's tax, whether it's a gift or it's income. Have to work through that. So that's different. The premise, right. Like I said, like a gift, there's unlimited spousal gifting. The Davis rules pre1984, which was a taxable distribution, but Davis was, was dealing with Delaware law. So you actually had different roles. If it was community property and it required state courts to look at the property ownership rights and they were just like, this is silly. So they changed the law for transfers after July 18, 1984. So you know, 1984, 40 years ago.

A (15:28)

Right.

B (15:29)

For the most part, doesn't exist. I Don't think you're going to have too many pre1984 divorces that are still going on. I surely hope not. That'd be something.

A (15:37)

Right.

B (15:38)

So you know the tax jumper 10:41 no tax even if a payment is made. It's a gift for income tax purposes. But it's basically a non taxable gift is how it works. You get a transfer or carryover basis. So if one spouse, you know, fair market value is 100, basis is 20, the other spouse fair market value is 100 and the basis is 20. Pretty simple. If the liability exceeds the basis, still non recognition. So that's interesting. And there's gain recognition If. Right. Section 1041E. The transfer is in trust and a liability is assumed or encumbering the property exceed basis. So you know, holding it in trust, whether it's actually in a trust or just in trust doesn't matter. Non recognition is generally mandatory.

A (16:20)

Right.

B (16:20)

Except for, you know what I was just talking about both gains and losses. And you need an actual transfer of property. So it happens on the earlier of the title, the transfer of title or the benefits or burdens of ownership. Burger versus Commissioner. It's a tax court memo from 96 and you use what's called the benefits and burdens test. Grote McKay Realty, which is another tax court case. I'm not going to discuss that in detail. But there's always questions as to whether and when the property transferred. And the key is, you know, whether the benefits and burdens of ownership can you be sued or getting the dividends from it, et cetera, et cetera. And I think that's really important. Even if title has not technically changed again, transfer or tax holding period under 1223 sub 2 and there is no depreciation recapture. There's a PLR on that. But if you sold, you may need to recapture upon sale sale. So let's say it gets transferred from one spouse to another upon divorce. A week later they sell it to an unrelated third party. This spouse may then have to recapture depreciation. So it depends.

A (17:17)

Right.

B (17:18)

You know, I refer to that as a future map problem. That answer is actually in the regs under 1245. The dash two regs. The character. The character is really interesting. 1.10411 D that's in temporary regs. So dash one T D and it's in Q and A 13 and basically the transfer, it's the same.

A (17:36)

Right?

B (17:37)

You keep the character, but the character can actually change to a different use. And you May need to recapture expense deduction when a business assets transferred. So you know, if you took a tax credit, you know, you think about the energy tax credits, right? Solar energy tax credits, and it gets transferred divorce and the person's no longer using it or it's used differently or it's not part of a trade or business, you may need to recapture credits or deductions. So definitely watch out for that. A lot of unexpected things in 179 that'll definitely hit you pretty hard. So what qualifies as a transfer incident to divorce to qualify for section 1041? The answer is it cannot be more than one year after the date the marriage ceases or it's related to the cessation of marriage. 1041c1c2. It has to be a transfer between spouses, I guess ex spouses at that point. Not necessarily a court order transfer, but you know, agreed by the by the spouses cannot be a court ordered sale to a third party. You know, a lot of times this is the marital house or they're selling a vacation house. You know, look for other reasons. I saw one once where they owned a piece of investment property and they were required to sell it. They first ticked it out, put it into ticks, Tennessee and Commons tenancies in common. There we go. Get the, get the plural correct. And they then sold and both 1031 separately. You can do that. There's some timing questions there. Well, we can, you know, another day, another thought. That's one option. You know, look at section 121. If you're selling the marital home, things like that, it is only related to the cessation of the marriage. If, if, if the transfer is one, pursuant to a divorce or separation instrument, again, writing is preferable, but not totally necessary. And two, not more than six years after the marriage ceases. If you get divorced and you're still fighting for six years, you have other problems and hopefully section 1041 will convince you to stop behaving like children and actually agree. I think that's necessary and helpful. However, right? If no divorce or separation instrument has been written, right. Or more than six years after divorce, there's a presumption, presumption that is not related to cessation of the marriage. The presumption is rebuttable. So you can say no, look at us, we're just jerks. But if that's the litigation you want to have, if that's the audit defense you want to have, have at it. But you have to look for Evidence of other factors. You know, there was one I dealt with years ago, but it wasn't dealt with because they didn't want to change ownership because there was an environmental issue and it had to be remediated and it took like nine years. So that one, you know, you have a fact pattern. It's, it's outside of the scope. But sometimes you do get people who are just, you know, scorched or fighting, right. That kind of stuff. The, the type of thing that in law and order leads to someone to, you know, try to kill the other or kill the judge or whatever. I think there actually was an episode dealing with a crooked judge and the judge having an issue. But anyway, neither here nor there, right? Even if the first agreement isn't working and you agree with second agreement, that's likely fine. You know, there's a tax court memo from 2016 that dealt with it, but it has to be related to the cessation of the marriage. What, what happens sometimes in this, this context is couple gets divorced, they had an agreement, you know, six, eight months later, then two years later they're having some fight and you know, you got this and I got this. They trade properties back or some asset gets transferred. Look, just enter a second one, make it very overt what you're doing. And you know, of course, as always, hope you don't get audited and deal with that.

A (20:55)

Right.

B (20:55)

I always say this, don't, don't be too cute, right? If the agreement is related to the cessation of the marriage, section 1041 applies. Say this, this is related to the cessation of the marriage. That's really important. So you know, there's some really interesting stuff dealing with when both spouses own stats stock in a company. So what happens, right? You have 50, 50, or they're 25, 25 with a partner and they're going to redeem one. There's a Treasury regulation, it's 10412 that deals with it and it's recast. So it's as if the redeeming spouse transfers stock to the non redeeming spouse, so it's no tax. The non redeeming spouse transfers stock to the corp. So the receiving spouse, I guess, you know, is redeemed, which is taxable, and then the cash is transferred to the redeeming spouse. And that's how it works out. So you know, if you're trying to structure around it or wiggle, it's tougher than you think. Especially if one spouse gets cash and the other one gets Ownership. So you know, there's, there's other ways to do it. You can do installment notes, things like that. You know, don't be too, you know, don't be too cute. So people always ask me, you know, what do you do in this situation? You use debt to pay without a redemption. So just buy from one. The other divorce triggers to buy, sell 1041 is not triggered actually because it's not on behalf of the ex spouse. There's a tax court case, blat I think so it's called, it deals with that. There's more to this one, but I'm kind of running low on time for how much time I want to spend on this specific discussion. I don't think it's that necessary. You know, just if you both own a business and one is going to be bought out, one of the two spouses can be bought out as a result of, you know, the divorce. Like let's think about it, talk it through and figure out, you know, really agree on what the tax consequences will be. And that's really important. So non 1041 transfers. Right. So people sometimes try to work around it. I've seen ones where they try to trigger tax or they're assigning income.

A (22:47)

Right.

B (22:47)

So the assignment of income, it's not discussed in 1041, Lucas v. Earl.

A (22:51)

Right.

B (22:51)

If you've, you've dealt with this one, this is an old, old, old. I think it's from the 20s Supreme Court case doing a tax and you cannot assign the right to receive income to another taxpayer. You can assign the property that generates the income. So you can't say hey ex spouse, you get 10% of my dividends. You can say hey ex spouse, I'm assigning 10% of the stock which will generate dividends. That you can do. So if you're trying to split between dividends and like capital proceeds, not so much. Not really saying you can do. Revenue ruling 2002 22. So the, in that one, the husband transferred NSOS to wife non qualified stock options. Non qualifying stock options. You think? I know. I did an episode about a couple months ago on this. There is no assignment of income, no income recognition. There is income when you exercise or sell. The NSO is a bit, basically it just says, look like we're just going to pretend that the NSO was granted to the, in this case the wife, husband transferred to the wife, which is generally consistent. If this were ISOs, incentive stock options, this would not be the case because you can't transfer ISOs. So you're just not allowed to do it by statute at that point they would actually become nsos which just have different tax consequences though not necessarily then marital home, right. No tax. If you're transferring half the marital home, there could be tax if sold. But generally, you know, code section121 shelters that it's an exclusion. And one thing that someone commented once and I, I tell you every so often, right. Someone says something and you just don't, you know, it's how the tax code is interrelated and what makes it so complex in a lot of ways is section 36, the first time home buyer credit. If you transfer, the new recipient is not eligible for that credit. So if they take out another mortgage or something else happens to pay it off, it's not their first home. It's both of you, even if only one spouse actually owned it before, which is really interesting. So. So watch out for it, you know, and that's really important. Marital home can be really kind of clunky, kind of quirky. I had one years ago where the marital home was transferred to one spouse and then it became not the marital home. They, they wanted to live elsewhere. They didn't sell it for a period of time. It was no longer eligible for section 121. So we actually ended up 1031 ing it, you know, doing a 1031 exchange. Used to buy another piece of property they would rather use for investment purposes. They turned a house into, I think it was an apartment that they rented out. I always forget it's been six or seven years. But it's, it's, you know, the kind of thing you have to do other, I don't say ancillary matters. Come out to talk about the children, right. The dependents. You must agree on what goes on the child tax credit and earned income tax credit really can matter. You know, obviously there's income thresholds, but if you have a spouse that makes, you know, $50,000 a year in income and this is, this is what people used to do with alimony is they would game the alimony child support amounts to basically maximize child tax credit and earn income tax credit.

A (25:42)

Right.

B (25:42)

That kind of stuff. You can't both claim them. But you know, depending on where the income lies and how you want to do it, who gets to claim the child for the deduction for credits, that can be really important. Filing status.

A (25:53)

Right.

B (25:53)

Married, filing jointly.

A (25:54)

Right.

B (25:55)

And then when you start the divorce, oftentimes you file separately. Sometimes they don't. Generally not a big fan of filing joint with someone who's going to get divorced. A little weird, but whatever. Once you're divorced, you know, you one of them if there's children, right? Head of household, if you qualify. Otherwise single. Someone once asked me, and I've run into this a couple times, particularly when I was at legal aid, is you don't actually have to get legally divorced to become single. Where it comes in and where the IRS just kind of allows it is where you have a situation where one spouse basically abandons the other spouse. I've seen it a few times where they just, they can't find them. So you can't serve papers, just start filing single. Consider yourself single, you're still legally married, you can't get remarried, but for tax purposes, you can actually file a single spouse. You know, so it goes innocent spouse, right? I, I, I've successfully requested innocent spouse for clients. You know, be like, oh, I was innocent. My husband did this, my husband did that. Well, look, if you knew about the income, you benefited from the income, you really have to not know what's going on. They have to prevent you from looking at the return. They have to prevent you from having any information. Financially, you can't go on all these fun vacations with the money that they're embezzling, et cetera. Hard to get. You know, I, I'm, I'm done at batting a thousand.

A (27:03)

Right.

B (27:04)

A hundred percent of the time because I don't do it all the time. There's other ways to do it. There's other things you can do. Gift tax, right? If it's after the 1041 period, the six years, you know, could have issues, could be gift tax, but you know, what is the key?

A (27:16)

Right?

B (27:16)

How am I summing this up?

A (27:17)

Right.

B (27:18)

Clear drafting. Say what you're doing. Don't hide, don't try to dilly dally, don't try to be cute. You know, pre and post nuptial agreements should be clear. And it's separation, divorce agreements, anything. Say what you're doing. You know, it's like anyone tells you for good writing, right? Say what you're going to do. Do it. Say what you did. That's really important. So that was the 15th episode of How Tax Works. I hope you learned something. Be back in two weeks in 2025 with the 16th episode. I'm going to be discussing common and interesting, hopefully interesting, right. Questions that people ask me when they find out that I'm a tax lawyer. Happy holidays and you know, talk to you. Well, I guess at you.

A (27:57)

Right.

B (27:57)

In 2025.

A (27:58)

Thank.

B (28:08)

You.