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Divorce and taxes – what you need to know

Divorce comes with all kinds of complications. You have to deal with dividing marital property, working out a custody schedule for the kids, find a new place to live and essentially start your life completely over. The other thing you may have to deal with is a large tax bill. Many couples fail to account for the tax consequences of how they treat and separate marital property.

Before you decide to sell the house in Denver or let your wife keep the lion's share of your investment accounts, you should find out the tax consequences that might occur due to your divorce settlement. In addition to your attorney, you should consider consulting your tax accountant and financial planner. Read further to find out more about taxes and divorce.

Tax-free settlements

The initial property settlement is generally tax-free. The Internal Revenue Code allows spouses that are both United States citizens to divide marital property without incurring any tax liabilities. However, it is what you do with the property after the divorce that might incur some rather large tax bills. For example, if you take the main residence that you originally purchased for $350,000 and eventually sell it, you risk incurring a capital gains tax if the sale price is substantially higher.

Transfers

If you and your spouse engage in a property transfer with each other, either during the marriage or within the first year after the divorce, it is also typically treated as a tax-free transaction. However, if you transfer property to your future ex-wife after the one-year "grace period," the Internal Revenue Service may want to take a closer look at the transaction.

Alimony

Alimony comes with tax consequences for both the payor and the payee. If you have to pay your wife alimony, you can deduct the expense on your tax return. Keep in mind that alimony must be part of the divorce decree or a separate maintenance agreement. Also, if you and your ex-wife are still residing under the same roof, the payments no longer qualify as alimony for tax purposes. In addition, the two of you cannot file a joint tax return and still claim an alimony deduction.

Audit risk

If you are paying alimony and claiming the expense as a tax deduction while your ex-wife is failing to claim the income on her tax return, prepare yourself for an audit. Alimony is often a red flag that can easily trigger an audit, especially in the first year you include it on your tax return.

There are many other tax issues that go hand-in-hand with divorce. That is why, when you are working toward a marital property division settlement with your attorney, you must take time to be sure you understand how each scenario could affect your future tax liabilities.

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