The IRS in the case of Stapleton v. Commissioner¸ TC Summary Opinion 2017-87, was challenging the taxpayer’s claimed capital loss carryover from 2012 to 2013 and 2014. The IRS specifically was taking the position that a sale of property by the taxpayer to his ex-spouse in 2012 related to the cessation of the prior marriage and thus a loss deduction was barred by IRC §1041(a)(2).
IRC §1041(a)(2) provides:
(a) General rule
No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)— …
(2) a former spouse, but only if the transfer is incident to the divorce.
Reg. §1.1041-1T(b), Q&A-7 provides the following discussion regarding what type of transfers would be “incident to the divorce” in a transfer to a former spouse:
Q-7: When is a transfer of property related to the cessation of the marriage?
A-7: A transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument, as defined in section 71(b)(2), and the transfer occurs not more than 6 years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or amendment to such decree or instrument. Any transfer not pursuant to a divorce or separation instrument and any transfer occurring more than 6 years after the cessation of the marriage is presumed to be not related to the cessation of the marriage. This presumption may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. For example, the presumption may be rebutted by showing that (a) the transfer was not made within the one- and six-year periods described above because of factors which hampered an earlier transfer of the property, such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.
In this case the couple had been divorced in 2007. As part of that divorce, the parties had agreed to transfer title to property referred to as the “Horse Ranch Property” to the husband, but subject to a special agreement that made each party responsible for payment of specific expenses related to that property. The agreement also provided that the husband would attempt to sell the property, providing that he would accept an offer that was at least 93% of the listed price. As well, if the property failed to sell by various dates, the husband would reduce the requested price by specified amounts at each date, again agreeing to accept any offer that was at least 93% of the price.
Due to the poor real estate market during the years at question, the property was not able to be sold despite the required reductions in the asking price. Finally, in November 2012, Mr. Stapleton asked his former spouse if she would agree to buy the property from him. She eventually agreed to buy the property from Mr. Stapleton for $175 000 and assuming the outstanding debts of over $2,000,000 on the property.
On their 2012 return, the Stapletons claimed a sizable loss, with $598,341 available for carryover into 2013. That loss offset capital gains of $23,918 in 2013 and $17,821 in 2014.
The IRS argued that this transaction was merely the final step in the division of the property between the ex-spouses and thus was “incident to the divorce” in which case no loss deduction would be allowed to Mr. Stapleton.
Mr. Stapleton argued that a transfer only relates to the cessation of marriage if it discharges a marital obligation, which this transaction did not do. But the Tax Court disagreed, noting:
Neither section 1041(c), the temporary regulation, nor the legislative history imposes such a restriction on the application of the statute.
Rather the opinion concluded:
What is clear on this record is that the division of the couple’s marital property, as prescribed by the MSA, was not complete until the ranch property was sold. As discussed above, both petitioner and Maureen Stapleton had retained significant rights and obligations in respect of the ranch property after their marriage was dissolved. We therefore conclude that petitioner’s sale of the property to Maureen Stapleton was made to effect the division of property that the couple owned at the time of the cessation of their marriage within the meaning of section 1.1041-1T(b), Q&A-7, Temporary Income Tax Regs., supra. Moreover, the sale was “related to the cessation of the marriage” when we construe section 1041(c) broadly in accordance with the legislative history of the provision and this Court’s caselaw.
For this reason, the Court disallowed the capital loss carryforward deduction on the 2013 and 2014 income tax returns.