September 1, 2016
As a divorce attorney or mediator you are familiar with the process of dividing assets, which typically include real estate, bank and investment accounts and personal property. But did you know some aspects of the tax return are divided too?
Mortgage Deduction. Typically the spouse remaining in the marital home will take over the mortgage payments, thereby earning the right to deduct the mortgage interest. But the IRS awards the mortgage deduction to the homeowner – regardless of who is living in the house - so if the spouse who owns the house moves out (and is still making the mortgage payments) he or she can still take the mortgage interest deduction. None of the payment is considered alimony because the spouse remaining in the house doesn’t own the house. Things get tricky when the house is co-owned but the spouse paying the mortgage has moved out. In that case half the payments are considered alimony (and are tax-deductible to the payor and taxable to the payee) while the other half is a straight interest tax deduction for the payor.
Income Producing Assets. The income from investment real estate, stocks, bonds and other income-producing assets will be taxable to the owner. If an asset was jointly owned before the divorce and subsequently awarded to one spouse, the income will be split equally for the period up to the date of the divorce and then taxable to the owner spouse after the divorce. Such income should be carefully considered when splitting assets if it is enough to cause a large tax liability.
Capital Gains. Capital gains, in the year they are generated, are always netted against capital losses for the same year. If there are any remaining losses then some may be used to offset a small amount of ordinary income and the remaining loss is carried forward to the next year, where the same steps are applied. The amount that is brought forward to the next tax year is called a “capital loss carryforward” or CLCF. These losses are valuable depending on your tax bracket – the higher your tax bracket the more money you save when you apply these losses against income. In a divorce the CLCF is split depending on who owned the property that generated the loss. If it was a stock in the wife’s investment account then the loss is hers to take with her. If it was generated by a mutual fund in a joint account then the loss should be split equally. You can see that this can get quite complicated if there are multiple years of losses.
Joint Estimated Tax Payments. These can be divided in any manner that the couple decide. An explanation of how the payments were divided should accompany the tax return. Also it’s important that both spouses don’t claim the same estimated tax payments.
Refunds Applied To The Following Year. The same approach used for estimated tax payments applies to overpayments from the previous tax year that were applied to the current tax year.
It is critical to review the tax return for the year prior to the divorce to uncover issues such as the above that will need to be addressed either during or right after the divorce. Cash may need to be generated in anticipation of an upcoming tax bill.