Divorce is often a complicated process. It often has far-reaching impacts that many people fail to predict. Divorce and taxes can be tricky to navigate. Who takes the carryover losses? How will that affect your financial planning? It’s important to speak to your advisor about this.
Tax Treatment of Carryovers
Tax carryovers come in many forms. This includes:
- Net operating losses
- Passive activity losses
- Capital losses
- Charitable contributions
- Alternative Minimum Tax (AMT) credits
However, it is important to understand that tax carryovers related to separate property are treated differently than those related to marital property. Separate property is property acquired by one spouse before the marriage or gifts/inheritances received by one spouse at any time.
Net Operating Loss Carryovers
If the allowable tax deductions for your business are more than its income, your net operating loss can be carried forward to subsequent tax periods. This helps reduce tax liability. However, IRS regulations stipulate that net operating loss carryovers must be divided in the same manner they would have been allocated if the divorcing spouses filed separate tax returns.
Passive-Activity Loss Carryovers
If a divorce includes the transfer of passive activities, like trade or business activities you and your spouse were not actively involved in, or rental activities, suspended losses are added to the tax basis of the assets being transferred.
These transfers are considered tax-free gifts between spouses. Therefore, the recipient acquires the basis of the spouse who made the transfer. Essentially, the suspended losses are transferred and become the basis for the gifted property.
Capital Loss Carryovers
When the sale of investment results in a loss, that loss may be used to offset capital gains. Alternatively, in the absence of gains, it can be used to lower ordinary tax liability by up to $3,000 per year. Capital losses can be carried forward into subsequent years as needed until they are fully deducted.
During a divorce, capital loss carryovers are generally allocated based on separate capital gain and loss calculations for each spouse. This ensures that the spouse who suffered the capital loss can use the carryover for tax purposes. If the losses were incurred jointly by both parties, the carryover is divided equally.
It’s important to note that some states choose to treat capital loss carryovers as marital property. This means it is subject to “equitable division” instead of allocating it to the spouse who actually suffered the loss.
Charitable Contribution Carryovers
IRS regulations stipulate that any charitable contribution carryovers must be divided in the same way and same proportion as the charitable contributions would have been divided if you and your spouse had remained married and filed separate tax returns.
AMT Credit Carryovers
Typically, AMT credit carryovers are allocated in the same manner as they would have been allocated if the parties filed separate returns. However, there is no official guidance from the IRS on their treatment.
Strategic Divorce Planning in Virginia
If you are in the process of a divorce or are recently divorced, it is important to speak to your financial advisor about the impacts of carryover losses on your financial plans. To learn more about dealing with carryover losses and divorce, contact Argent Bridge Advisors.