Images
Transfers of Assets in a Divorce Part III of III
June 24, 2010
CARRYOVER ITEMS
There are a variety of potential carryover items that could be on a return. Carryover items are deductions or income claimed on a return in one year, but due to various tax situations, may not be deductible until some point in the future. Examples of how to treat those items are as follows:
Capital Losses
These must be allocated based upon the separate gains and losses of the spouses (Reg 1.1212-1(c)(1)(iv). This means you may have to go back a number of years to determine which stocks (and from which accounts) the losses were actually generated. If the loss was from a joint account, the loss will be carried over equally by each spouse.
Charitable Contributions
If the carryover was generated from a joint return, but not joint accounts, then you must recalculate the incident year as if they filed separately (Reg 1.170A-10(d)(4)). Allocations by agreement of the parties are NOT permitted(Rev Rul 76-267).
Passive Activity Losses (PAL)
A PAL is generally from a business that is partially owned by a taxpayer, who does not spend much time with the business (a passive activity). Losses from these types of businesses are only allowed to be taken when income is generated from other passive activities.
Suspended PALs do not carryover with the asset, and are added to the basis of the stock when gifted; therefore they are not realized until the asset is sold. A transfer pursuant to a divorce is treated as a gift for tax purposes. Therefore, if a taxpayer paid $10,000 for a partial share of a business, and there is a $5,000 PAL at the time of transfer, the spouse would have a $15,000 basis in the stock when it is eventually sold. However, this turns a potential ordinary tax loss into a capital loss that also may be limited in future use. This may be a situation where the six-year transfer period under §1041 (mentioned in the first section) may be beneficial. If the taxpayer could hold on to that stock for a few years until the entire PAL is used, the stock could then be transferred with no detriment to either taxpayer.
At Risk Limitations
Generally the IRS does not let a taxpayer take a loss from a business ownership in excess of what the owner put into the company. If the taxpayer purchased a partial interest of an S-Corporation for $10,000, and the first year's losses were $20,000, he or she would only be able to deduct the $10,000 he or she had "at-risk" and the rest would carry over until there was enough income generated to enable him or her to take the loss.
This loss also does not follow the stock and would be lost if the ownership of this asset was transferred to the spouse. In addition to the planning suggestion listed in the PAL section, another option would be to have the taxpayer ‘contribute' in cash the amount of the loss to the company in lieu of cash owed to the spouse via the property settlement. This would then allow the taxpayer to take the carryover loss on his or her separate return.
Net Operating Losses
These must be allocated between spouses in the ratio of what the separate NOL carryforwards would have been if each spouse computed income and deductions separately.
Investment Interest Expense
Any reasonable method may be used.
Alternative Minimum Tax (AMT) Carryovers
There is no set authority on how to properly allocate AMT carryovers. All of these carryovers result from ‘timing' differences on properties and/or flow through entities. The best allocation would probably be to prorate the carryovers based on the amount of income from those properties.
There are a variety of other issues dealing with divorce that taxpayers need to know well in advance of signing the final papers. This three part series was designed only to touch briefly on some of the more common ones. Please contact one of our associates specializing in this area if you have detailed questions that were not covered in this article.
by: Richard L. Craig, CPA/ABV/CFF, CVA, CITP, MCP
