No gain or loss is recognized when property is transferred between spouses during marriage. This rule applies also to transfers between former spouses if “incident to a divorce.” A transfer is considered an incident to divorce if it occurs within one year after a marriage ends or is related to the ending of a marriage (i.e., occurs within 6 years after a marriage ends and the transfer is made under a divorce or separation agreement). A transfer that occurs later than 6 years after a marriage end can be considered incident to divorce if the taxpayer can show that legal factors prevented earlier transfer of the property.

The Tax Court has held that where a couple provided in their divorce agreement that they would each own 50% of their businesses but decided over a year later that this arrangement wasn't working, the ex-husband's sale of his 50% interest to the ex-wife was nontaxable because it was incident to the divorce. (Belot, TC Memo 2016-113)

The basis of the property received in a transfer between spouses or former spouses is the adjusted basis the transferring spouse had in the property. In effect, the recipient spouse has received a gift of the transferred property.

Under IRC §§ 1041(b) and 469(j)(6), if a taxpayer transfers property to a spouse incident to a divorce, the exchange is treated as though it were a gift. Therefore, any suspended losses attributable to the spouse giving up the interest in the passive activity are added to the basis of the property transferred to the other spouse. For the receiving spouse, the basis will be increased by the ex-spouse’s suspended losses, but the receiving spouse’s suspended losses on the same property will still be considered suspended losses, which are available currently to offset passive income.

For an individual holding property transferred between spouses or transfers incident to divorce, the period the individual owns the property includes the period the transferor owned the property.

Only for purposes of the Sec 121 home gain exclusion is an individual treated as using property as the individual’s principal residence during any period of ownership while the individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument. This means that if a husband (or wife) continues to own the home after a divorce, and his/her former wife (husband) is granted use of the property under a divorce instrument, the exclusion could be available when the husband (wife) sells the house if he (she) meets the ownership requirement, and his wife (her husband) meets the use requirements. (Reg. §1.121-4(b)(2))

Where a home is sold that is subject to a homebuyer or long-term resident credit recapture (see chapter 9.14), and the credit had been claimed on a joint return, each spouse is treated as having received half the credit for recapture purposes. Where one spouse retains the home in a property settlement, recapture or repayment is not triggered because of the settlement. However, that spouse takes full responsibility for any subsequent repayment or recapture of the credit. This rule is like the Sec 121 home gain rules.