Many people mistakenly believe that California’s community property laws make it simple to divide property in divorce. The thinking is that if both spouses get half, how hard can it be to figure out?
The answer is that it can be extremely difficult–if you’re paying attention to the right details. One of those details is liability for capital gains tax. Both the federal government and the state of California impose significant taxes on capital gains and if you don’t account for the potential tax liability when dividing property, one spouse could easily end up with an unequal share of the true value of marital assets.
The Transfer in Divorce is Not the Issue
Under California law, property acquired during the marriage is jointly owned by both spouses, even if one spouse earned it or bought it. This property gets divided during the divorce process, but it is usually not a literal division. No one wants half a car, for instance. Instead, couples generally assign a value to each asset and then develop a plan to allocate assets worth half the value to one spouse and half of the value to the other. During the process, assets may be transferred between spouses. A car titled in both names may be retitled in the name of one spouse or a new deed may be created transferring the family from both partners or the name of one partner.
The transfers that occur in the process of dividing assets during divorce generally do not trigger tax liability. What you need to be aware of is the potential for capital gains tax after the divorce because that potential can affect the current value of an asset.
Understanding State and Federal Capital Gains Tax
Capital gains tax is a tax obligation based on the profit earned from selling an investment. That investment could include stocks, bonds, collectibles, real estate, or anything that increases in value. For instance, if you bought 100 shares of stock when it was selling for $5 a share and you sell those shares when the price has gone up to $8 per share, then you have reaped a capital gain of $3 per share or $300. That $300 will be taxed by both the federal government and the state of California at the applicable capital gains rate. The rate varies according to factors such as how long you have held the investment and your overall tax bracket.
How Capital Gains Taxes Can Impact Assets in Divorce
The reason you need to pay attention to capital gains tax during divorce is that it impacts the value of assets. If you own $1,000 worth of stock in ABC corporation and $1,000 worth of stock in XYZ corporation, their actual value might be different when you take capital gains tax into consideration. You might have purchased the ABC stock years ago when it only cost $250 while the XYZ stock might be a recent purchase that hasn’t gone up much in value. If a marriage settlement gives one spouse the ABC stock while the other spouse takes the XYZ stock, the spouse with the ABC stock will eventually owe capital gains tax on the $750 increase in value while the spouse with the XYZ stock may not owe any capital gains tax at all. Even if you don’t plan to sell an asset immediately, you need to consider whether it has appreciated in value and how much tax you would owe if you were to sell it. Subtracting that amount gives you a more accurate picture of the true value of that asset.
This can be complicated to calculate in some situations, such as when you have been acquiring stock gradually over the years as part of a profit sharing plan. But if you want to ensure that your property division agreement is truly fair, it is important to work with an attorney who is willing to delve into these details.
The Team at Holstrom, Block & Parke Understands How to Protect Your Interests in Community Property
Capital gains tax liability is just one of many factors that can affect the real value of your property settlement in a California divorce. The Certified Family Law Specialists and associates at Holstrom, Block & Parke, APLC can help you accurately assess all property and debts to help you keep your separate property and get the correct share of community property. For a confidential consultation to learn more about the ways we can safeguard your interests in divorce, contact us today.
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