136 DIVorCe wItH DeCenCY
individual tax-free retirement accounts via a rollover procedure,
rather than having either party take an early withdrawal.
As if the divorce itself isn’t taxing enough. What happens when
a spouse sells an asset that has appreciated over time? Suppose
John and Mary bought two hundred shares of Microsoft Corpo-
ration when they got married some twenty years ago. In those
pre-Windows days, it cost them only $10,000. Today, it’s worth as
much as the $200,000 condo they just bought. When they divorce,
they agree that John gets the condo and Mary gets the stock. This
is a nontaxable event and it appears to be an equal split, but it’s
not really a fair trade. Eventually, Mary will sell the stock and
then she will have to pay capital gains on its entire appreciation
($190,000).
The rule is simple: the person who receives an asset will be
responsible for the tax on the appreciation when that asset is sold.
No “step up” in basis for capital gains purposes occurs as part of
the divorce. Thus, even if you are dividing up assets of equiva-
lent present value, you may be smart to take the one with the
higher original cost basis and/or the lower appreciation. Fortu-
nately, the Bush administration’s 2003 tax reforms have lessened
the sting a little. The new law lowers the top capital gains rate to
15 percent.
Often divorcing couples sell the former marital residence.
When this occurs, there are special rules for treatment of capital
gains. Current tax law provides that, regardless of your age, if
you have owned and used the home as a principal residence for
at least two of the five years before the sale, you can exclude up to
$250,000 of gain ($500,000 for joint filers). This exclusion can gen-
erally be used only once every two years. In the John and Mary
example above, John could live in the condo and eventually sell
it for up to $250,000 over the original price without incurring any
capital gains tax.
Tax timing. If a divorcing couple sells the residence incident
to divorce, they may want to file jointly in order to take advan-
tage of the $500,000 capital gains exclusion. They may also want
to file jointly for one more year for other tax benefits. If you are
divorced by the end of the calendar year, you are deemed to be
single for that entire year for tax purposes. Thus, if you want to