AFTER-TAX VALUE OF MARITAL ASSETS

An asset schedule lists what things are worth. It does not list what they are worth after tax, and those are different numbers — sometimes by a great deal.

A settlement that divides the schedule down the middle can transfer substantially more value to one spouse than the other, and do it without either side intending to.

THE SAME NUMBER, DIFFERENT VALUE

Consider three assets each carried at $1,000,000:

• A brokerage account with a $950,000 basis. Sell it and the gain is $50,000. Nearly all of the face value is available.
• A rental property with a $300,000 adjusted basis after years of depreciation. On sale there is capital gain and depreciation recapture, taxed at a higher rate. The after-tax proceeds are materially below face.
• A traditional retirement account. Every dollar comes out as ordinary income at the recipient’s marginal rate, and early withdrawal adds a penalty.

Three identical numbers on the schedule. Three quite different amounts of spendable money. A division that treats them as equivalent is not an equal division.

WHAT DRIVES THE DIFFERENCE

• Basis. What was paid, adjusted for improvements, depreciation, and prior transactions. Under section 1041 a transfer between spouses incident to divorce is generally not taxable — but the basis carries over, and so does the gain.
• Depreciation recapture. Depreciation taken on real property is recaptured on disposition at a rate above the long-term capital gain rate.
• Character. Ordinary income, short-term gain, long-term gain, and qualified dividends are taxed differently. Character travels with the asset.
• Suspended passive losses. Losses suspended under section 469 attach to the activity and the taxpayer. They can be a meaningful asset — and they follow the property.
• Liquidity and timing. An asset that cannot be sold without triggering tax, or cannot be sold at all, is not the equivalent of cash at the same number.
• Holding period. Whether a sale is short-term or long-term can be a twenty-point difference on the same gain.

SECTION 1041 IS NOT AN EXEMPTION

Interspousal transfers incident to divorce are generally non-recognition events under section 1041. That is frequently misread as meaning the transfer is tax-free. It is not — it is tax-deferred. The basis carries over and the gain is realized by whoever ultimately sells.

Which means the spouse who accepts an appreciated asset accepts a future tax bill that does not appear on any schedule.

WHAT THE FIRM DOES

Reprices the schedule on an after-tax basis so both sides are negotiating over comparable numbers, identifies where value is hiding, and works with the litigator and forensic accountant to structure the division around what the tax analysis actually shows.