Benjamin Franklin once said that nothing in this world is certain, except death and taxes. One of the exceptions, however, is the transfer of marital property in a divorce. Transfer of marital property is not a taxable event under Section 1041 of the IRS Code. However, embedded taxes can result in a lower valuation. Other specific tax situations that we commonly see in a divorce are:
Ryan Kalamaya explains some basic tax situations that can occur in a divorce in the state of Colorado.
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Ryan Kalamaya (1s):
Welcome to Divorce at Altitude, A Podcast on Colorado Family Law. I'm Ryan Kalamaya each week, along with my business partner and cohost Amy Gosha or an expert, we discuss a particular topic related divorce or co parenting in Colorado. In addition, we have created a short series of lessons that will take you through the legal process of divorce and answer your questions from simple to complex divorce. Isn't easy. The end of a marriage, especially when children are involved, brings a great deal of loss and change. We hope these practical tips and insights will help you On your journey to a new and better life.
Ryan Kalamaya (43s):
This how to episode about taxes and the impact that they can have on property valuations in Colorado divorce. Now, Benjamin Franklin, one of our founding fathers is frequently credited as the author of the saying that there's nothing in this world that certain except for death and taxes. However, the certainty of taxes is really a key component in whether or not they can matter for a valuation and in call divorce. And we'll talk about that. But before we get into that, let me first give you the lawyerly caveat and advice that I'm not a tax attorney. I'm not a CPA, so this is supposed to be educational only. And if you have any sort of issues requiring tax advice, you need to consult with an expert and this should not be relied upon, but it's hopefully giving you an overview of how taxes can really matter.
Ryan Kalamaya (1m 33s):
Cause they can really drive oh, valuations in a collar, a divorce. Now let me first begin by addressing one of the most frequently asked questions. And that is that if there is a transfer in a divorce. So if property is transferred from one spouse to the other, does that result in some sort of significant tax spill? And is that really a taxable event? The short answer is no under 10 41 of the IRS tax code transfers incident to a divorce or not a taxable event. However, the spouse that receives property takes it with the tax basis of whatever is in that property. So an example would be in our hypothetical divorce story involving Eric and Melanie Wolf.
Ryan Kalamaya (2m 13s):
If Eric transfers a property to Melanie and there is a basis of 50, then that she's going to take the property with a basis of 50 and really what we'll flesh out that concept. When we talk about how that can matter in valuations. So embedded taxes can result in a lower valuation. That's a key takeaway from this episode. And really the example that we can give is if Eric has a million dollars in cash and he gives that cash to Melanie, then she's probably not going to owe any taxes on it because the income that it came from, Eric and his work they've already been paid.
Ryan Kalamaya (2m 55s):
So she's going to get a million dollars in cash. And if she withdraws it each and every month, she's not going to have any sort of tax consequences. She's not going to owe any taxes easily enough to understand when you compare that to let's say a million dollar stock portfolio, that could really be a significant difference if that portfolio has doubled over the course of the marriage. So if it's worth a million dollars, but the tax basis is $500,000. Well, Melanie's going to get a significant tax bill if, and this is a critical issue. She sells the stock and that under in your marriage of finer. And some other cases in Colorado is the key decision is whether or not there's actually going to be a realization of the taxable event.
Ryan Kalamaya (3m 39s):
So, and if you want to go back to episode 65, you can see this at play. When I discuss what happens to a house in a Colorado divorce, cause the same concept applies for real estate, commissions and taxes. If Melanie gets a house, let's say it's the marital house. And she intends to restate in that house. Well, she's not going to have a reduction in the value of that property because of the commission and most importantly and salient for this episode, the taxes. So, but we can also go back to our other example and really kind of show the impact of taxes. And that is if we compare Eric Wolf's million dollars in the bank, that's going to be different than a million dollars in a retirement account.
Ryan Kalamaya (4m 22s):
And that's because most retirement counselors say it's a 401k or it's a traditional IRA. And he transfers over that million dollars in a retirement account to Melanie, she's going to pay taxes on any sort of withdrawals. And that is maybe above and beyond the penalties that would accrue. And it would depend on her age. And you can go back to the how to episodes that we have on division of retirement accounts, where this really comes into play in taxes and whether or not it's going to occur or it's going to be speculative, but it can really drive some significant differences in opinion, as to values. And usually that's going to mean expert witnesses, but you're going to look or see that at play when you are dealing with pensions partnership interests.
Ryan Kalamaya (5m 7s):
So if Eric is a partner in a law firm, he is going to say, well, my partnership interests, I'm going to have to pay taxes on that. And really the question becomes, is he going to continue to be a partner in that law firm? Or if he's a doctor in a medical practice, is he actually going to sell that anytime soon, it could batter if Eric is 65 years old and he's on his way to retirement, where there's an active lead negotiations on buying him out versus him just graduating from medical school and going through residency and becoming a partner immediately, there's going to be a fundamental difference. And it's really up to the core on whether or not taxes are going to matter stocks and bonds.
Ryan Kalamaya (5m 48s):
As you can tell from my earlier example on the stock portfolio can really matter. And I will tell you that I have seen some seasoned divorce attorneys really miss the boat. And oftentimes what we will do is ask for the investment statements that show the tax basis. Because the last thing that we want is for our client to take a effectively, a ticking time bomb when it comes to taxes, trusts, interests can also be impacted significantly by taxes and investment properties. So if Eric owns a commercial building down in Denver and he's had that for quite a while, then he's probably taken depreciation and there could be some gain if the property prices have gone up.
Ryan Kalamaya (6m 29s):
So, but again, we're getting into, is he actually going to realize those taxes any time soon if we're talking about taxes and property, we should also probably mention the $500,000 exclusion on taxes for gain in a marital house for personal residence. But again, that's, if you're going to sell it. And it's also, there's some time restrictions and various other use restrictions or ownership restrictions on that particular provision, I'll wrap up and identify a couple, you know, new fangled or other issues that are frequently missed even by the most kind of seasoned divorce lawyers. And that would be tax loss, carry forwards. There's two different kinds of tax loss, carry forwards, there's net operating losses for a business.
Ryan Kalamaya (7m 11s):
And then there's also a capital loss carry forward. So if Eric, for example, had a stock portfolio and he sold off a bunch of stock and lost a bunch of money, there's various restrictions on whether or not he can apply that. And he might be sitting on some losses that could be used, wipe out future income. Anytime we were talking about taxes, we're also talking about different kinds of taxes. There is capital loss or not capital loss, but rather short term gain. And long-term gain. There's going to be different rates compared to ordinary income. And really again, I want to reiterate, you're talking about expert witnesses whenever you are dealing with taxes, but I hope that this has been helpful because taxes can really, really drive and valuations and old Ben, you know, there might be a certainty in death and taxes, but in a divorce, it's really gonna depend on what the likelihood of the realization of those taxes as well as the rate that one would use.
Ryan Kalamaya (8m 8s):
So, but for now, hopefully that's helpful information for you when talking about taxes and divorce. Thanks for listening or watching this short lesson on the Divorce at Altitude podcast. If you found this helpful, please leave a review or share with a friend. It does help for others that are going through or thinking about a divorce in Colorado. If you want to find out more information, please visit Kalamaya dot law or Divorce at Altitude dot com. And that's K a L a M a Y a.law. Remember, this is educational information. It's not intended to be legal advice. Please consult with an attorney about the particulars of your case. We're happy to answer questions, feel free to give us a call at (970) 315-2365.