Divorce and taxes: Understand some of the issues that can arise

On Behalf of | Apr 24, 2023 | Income Tax

Once you put the emotions of a divorce aside, a lot of what’s left to handle is purely financial. If you don’t have any real assets or investments, it might be fairly easy. If you do, however, the divorce process can get exceedingly complex.

Couples sometimes forget about taxes when they’re dividing up the marital estate, and that’s a serious mistake. Here are some of the issues that can arise:

Capital gains on the liquidation of long-term investments

Couples often need to divide long-term investments such as stocks, bonds, and real estate. If these assets have appreciated in value since they were acquired, the sale of these assets can result in capital gains tax.

Capital gains tax is calculated based on the difference between the asset’s sale price and its cost basis (purchase price). Depending on the length of time the asset was held, the tax rate can vary, since long-term investments are taxed at a lower rate than short-term investments.

The IRS alimony recapture rules

The IRS has specific rules regarding alimony payments, including a provision known as alimony recapture, which applies when the total amount of alimony paid in the first three years after the divorce is substantially reduced in the third year. The goal of this rule is to stop payments as part of a property settlement from being improperly characterized as alimony for tax purposes, which is illegal.

Tax consequences on the sale of the marital residence

Another asset that is often divided during a divorce is the marital residence, and selling it to divide the proceeds is common. If the sale of the house results in a gain that exceeds the exclusion that the IRS grants couples for a primary residence, the parties will need to pay capital gains tax on the excess amount.

Allocation of the dependency exemptions

The tax deductions that can be claimed for dependent children are valuable, so the issue of which parent gets the deduction can be contentious. In some cases, parents will agree to alternate years in which they claim the exemption. However, it’s important to ensure that both parents understand the tax implications of this arrangement and how it will affect their tax returns.

Ultimately, the tax consequences of a divorce can be very hard to understand, which is why it’s usually best to seek experienced guidance as you go.