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Are Transfers between Spouses Taxable?

Transfers between spouses are generally nontaxable, but some exceptions exist. Generally, no gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse or, if the transfer is incident to a divorce, a former spouse. The following questions and answers describe more fully the scope, tax consequences and other rules which apply to transfers of property under section 1041.

IRC section 1041 Internal Revenue Code section 1041(b) generally makes transfers to nonresident spouses subject to income tax gain or loss recognition.  That is not the only problem that applies to transfer between spouses or former spouses when the international tax rules start to apply.

A transfer within the scope of Section 1041 is treated as a gift for income tax purposes. That is how the income tax rules cause such a transfer to escape gain or loss recognition, and to cause the recipient to have the giver’s basis.

Applicable Gift Tax Rules

IRC section 2501(a)(1) imposes a tax on transfers of property by gift.  It is sufficiently broad that it would apply to transfers between spouses and former spouses. However, there are a number of exceptions that can be used to reduce or eliminate the gift tax on interspousal transfers, either while the couple is married or incident to a divorce.

Examples of the taxation of transfers between spouses

Example 1. A and B are married and file a joint return. A is the sole owner of a condominium unit. A sale or gift of the condominium from A to B is a transfer which is subject to the rules of section 1041.

Example 2. A and B are married and file separate returns. A is the owner of an independent sole proprietorship, X Company. In the ordinary course of business, X Company makes a sale of property to B. This sale is a transfer of property between spouses and is subject to the rules of section 1041.

Example 3. Assume the same facts as in example (2), except that X Company is a corporation wholly owned by A. This sale is not a sale between spouses subject to the rules of section 1041. However, in appropriate circumstances, general tax principles, including the step-transaction doctrine, may be applicable in recharacterizing the transaction.

Contact a tax attorney to discuss your questions if you have received an IRS audit letter, or have questions about the taxation of transfers between spouses.