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The tax law has a broad definition of a 鈥渟ale or exchange.鈥� This matters because sales and exchanges produce taxable gains and losses.

Technically, the statute refers to 鈥渟ales and other dispositions鈥� of property. That is, if you dispose of property, the general rule is that you have a taxable transaction.

There are, of course, exceptions. The focus of this column is an exception that applies when property is transferred 鈥渋ncident to divorce.鈥�

A divorce involves dividing up property. If we divorce, and I take my property and you take yours, no one has 鈥渢ransferred鈥� property.

But it is common for one spouse to agree to transfer all or a portion of his or her property as part of a settlement of the terms of the divorce.

In general, the transferor would be required to treat the transfer as taxable. The excess of the fair value of the property over the tax basis would be a taxable gain.

This was once the law. Abraham Lincoln said the best way to repeal a bad law is to enforce it strictly.

No one felt it was fair to create a taxable event when spouses divided property as part of a divorce. This bad law was repealed.

The law now says that no gain or loss is recognized when property is transferred 鈥渋ncident to divorce.鈥�

The tricky thing about laws is that we always end up asking, what do you mean by those words?

In ideal circumstances, the drafters of the law anticipate our question. They then include a plain language definition of the law鈥檚 terms.

This law says two things about 鈥渋ncident to.鈥� First, it includes any transfer that occurs within one year after the date the marriage has ceased.

Second, it includes any transfer that is 鈥渞elated to the cessation of the marriage.鈥� That one is a bit more nebulous.

Tax regulations exist to clarify the terms of the law and clear up the haze that surrounds terms like 鈥渞elated to the cessation of the marriage.鈥�

The regulations tell us that a transfer within one year will qualify for no gain, even if it is not related to the divorce.

They also tell us that the hazy test is met if the transfer is made pursuant to a divorce or separation agreement, and it occurs within six years after the marriage ends.

So, the one-year period does not require proof of a connection to the cessation of the marriage.

Transfers after one year can satisfy the six-year test provided there is a link to the instrument that terminates the marriage.

Transfers that fail to satisfy either one of these tests are presumed not related to the cessation of the marriage. That means the transfers are fully taxable exchanges.

The one-year test is objective. As noted, it does not require any evidence of a link between the transfer and the divorce.

The six-year test requires an explicit link to the divorce or separation agreement. It presents a form of protection from IRS challenge, but also has a way to stretch its benefits.

The regulations tell us that transfers outside the six-year period are presumed not to be related to the divorce.

Presumptions can be overcome with evidence. In one case, the IRS approved a transfer beyond six years that was delayed by factors beyond the taxpayer鈥檚 control.

The property was an interest in a business, and there were protracted disputes about value and payment terms.

The transfer occurred beyond six years but soon after the disputes were resolved to the satisfaction of all affected parties.

If the requirements of the statute and regulations are satisfied, the transferor spouse can avoid any gain from the exchange of property for marital rights.

But someone eventually must pay the tax attributable to any potential gain. This is done by assigning the transferee spouse on the same basis as the transferor.

So, the potential tax liability from a value more than the tax basis is shifted from one party to another.

The spouse who receives the property needs to understand this and that the total value received from dissolution of the marriage is reduced by the future tax liability.

It is important for both spouses to get good tax counsel as part of the divorce, and each should seek out their own tax adviser.

Jim Hamill is the director of tax practice at Reynolds, Hix & Co. in sa国际传媒官网网页入口. He can be reached at jimhamill@rhcocpa.com.