Category: Sales & Exchanges; Individuals
Subject: Transfer of Installment Obligation
Title: Transfer Pursuant to Divorce--Affects on Unrecognized Gain and Basis
IRC Sections: 453B(g)(1), 1041
Filename: 1153.html
Date Produced: 5/96 Copyright 1998, The Tax Resource Group. All rights reserved. Telephone
800-578-3498. Internet: www.taxresourcegroup.com Background
Prior to his marriage in 1986, Husband (H) sold a business in exchange for
cash and an installment obligation with a gross profit percentage of 90%.
Pursuant to a prenuptial agreement, in the event of divorce H was obligated
to give $2.2 million to Wife (W) in recognition of separate property she
contributed to marriage. H and W divorced in 1989. In full settlement of
H's obligation under the prenuptial agreement, H transferred to W an installment
note (or portion thereof) with a face value of $1.35 million. In 1991, W
discounted the note back to the maker. Issues
1. Does the transfer of the installment note pursuant to the divorce trigger
the unrecognized gain in the installment note? 2. What is W's basis in the installment note? Answers
1. The transfer of the note pursuant to the divorce does not trigger the
unrecognized gain. 2. W's basis in the installment note is H's basis at the time of the
note's transfer plus or minus any adjustments necessary for events subsequent
to that transfer. Discussion
It is very clear that transfer of an installment note pursuant to a divorce
does not constitute a disposition of the obligation. Accordingly, H was
not required to recognize the remaining installment profit at the time of
the transfer. IRC Section 453B(g)(1). This provision was enacted in 1984
in almost the exact same form as exists today; accordingly, the rule in
question was effective at the date H transferred the obligation to W in
settlement of his marital property obligations to her as set forth in their
prenuptial agreement. W effectively "steps into the shoes" of
H with respect to the installment reporting. Since H was not required to recognize the unreported installment profit
as a result of the transfer of the note, his basis at the time of transfer
should have been approximately 10% of the remaining note balance, given
a 90% gross profit percentage. IRC Section 1041 provides that a transfer of property to a former spouse
incident to a divorce is treated for income tax purposes as a gift, and
the basis of such property in the hands of the transferee spouse is the
adjusted basis of the property in the hands of the transferor. A transfer is considered incident to a divorce for this purpose if the
transfer is made within one year after the divorce and is related to the
cessation of marriage. Based on our conversations, the transfer in question
seems to be rater obviously related to cessation of the marriage. I would
inquire with your client as to its timing. | 
