When navigating the dissolution of a high-net-worth marriage, attorneys are often laser-focused on equitable division and legal compliance. But overlooking capital gains tax implications in asset division can lead to costly, unintended consequences for your clients.
High-value portfolios — including real estate, investment accounts, business interests, and collectibles — often come with significant unrealized capital gains. And while transfers between spouses during divorce are generally non-taxable under IRC Section 1041, what happens after is where the real impact lies.
Below is a strategic overview to help you better serve your clients by proactively addressing capital gains during divorce proceedings.
Capital Gains & Divorce: The Essentials
- IRC Section 1041 Transfers
Transfer of property between spouses or incident to divorce are generally non-recognition events. This means no immediate tax is due at the time of transfer. However, the original cost basis and holding period carry over to the receiving spouse. - Built-In Gains Trap
If one spouse receives an asset with significant unrealized gains, and then sells it post-divorce, they may face a large capital gains tax burden — even if they received that asset “tax-free” during the split. - Property Type Matters
Primary residences, rental properties, stocks, private equity interests, and art/collectibles all carry different rules, exemptions, and tax treatments. For example:- Primary residence exclusion may be lost or limited post-divorce. If the primary residence has appreciation, it could result in additional tax if sold by a taxpayer now filing single or head of household.
- Carried interests or restricted stock may have complex vesting or valuation implications.
- State Tax Differences
If spouses reside in different states, state capital gains treatment can differ widely and should be factored into the settlement strategy. - Rental Real Estate
Can also carry accumulated depreciation which is taxed additionally at the sale of the property.
Attorney’s Capital Gains Consideration Checklist
Use this checklist to guide your client conversations and collaborate more effectively with financial and tax professionals:
Asset Review
- Identify all assets with unrealized capital gains or losses.
- Determine cost basis and holding periods for each asset.
- Flag assets with illiquid or complex valuation (e.g., business ownership, private equity).
Equitable + Tax-Efficient Division
- Ensure division is not just equal in value, but fair in after-tax value.
- Run hypothetical sale scenarios to project potential capital gains tax burden for each spouse.
Real Estate Considerations
- Confirm if primary residence exclusion ($250k per spouse) still applies.
- Assess whether post-divorce use affects exclusion eligibility.
- If keeping the house, calculate future capital gains exposure.
Investment & Business Interests
- Clarify ownership of carried interest, restricted stock, or deferred comp.
- Address control, voting rights, and liquidation potential.
- Consider installment sale structures or Qualified Domestic Relations Orders (QDROs) where applicable.
Client Preparation
- Recommend a joint session with a CPA or tax advisor before finalizing settlement.
- Encourage tax projections to inform decision-making, not just after-the-fact reporting.
- Emphasize post-divorce tax planning to avoid surprises at sale or filing time.
Download your checklist here.
Final Thought
Divorce is already emotionally and financially taxing. For high-net-worth clients, it can also trigger steep and unexpected tax bills if capital gains implications aren’t fully considered. As a trusted legal advisor, you can elevate your counsel by ensuring that asset division accounts for both legal equity and tax efficiency — ideally in collaboration with a qualified tax consultant.
If you’re an attorney seeking strategic tax insights for your client’s divorce proceedings, We are available for consults and white-glove collaboration. Let’s help your client land on both feet — legally and financially.