Divorce is a very stressful time but the complexities of the US tax rules when a non-US spouse is involved add an additional layer of complexity.
Under the general US tax rules, when assets are transferred between spouses incident to a divorce there is no realisation of a gain or loss by the transferor-spouse. Instead, the transfer is treated as a gift. If the spouses are both US citizens, the case is straightforward and simple and no US Income tax or Gift tax consequences will result. A transfer is treated as incident to a divorce if it takes place within a year of the divorce or is “related to the cessation of the marriage”. Generally, a transfer is related to the cessation of the marriage if it is pursuant to a divorce or separation agreement and occurs not more than 6 years after the date on which the marriage ceases. If one spouse is a non-US citizen the situation become more complex and even more so if the non-citizen spouse is also a Non-Resident Alien (NRA).
In order for the income tax-free treatment to apply, the recipient of the property cannot be a Non-Resident Alien” (NRA). For example, if you transfer appreciated stock to your NRA spouse as part of the divorce settlement, you will have to pay tax on the inherent gain in the stock, generally just as if you sold it.
When the recipient spouse is a US citizen, the Gift Tax will not apply because gifts made between spouses are entitled to an unlimited marital deduction which shields the giver from US Gift Tax. The key here is that the recipient must be a US citizen.
When the recipient spouse is not a US citizen, the unlimited federal gift tax marital deduction does not apply. Instead, gifts to non US citizen spouses have an annual exclusion which is indexed annually for inflation. For 2018, the amount that can be given to a non US citizen spouse free of US Gift Tax is $150,000.
The combination of the US Income Tax and US Gift tax rules means that every property settlement incident to a divorce when the recipient is not a US citizen must be scrutinised for both potential Income tax and Gift tax liability which can be imposed on the transferor-spouse
Basis of Asset Received in Divorce Settlement
If the spouse receiving the assets is a US Citizen a property settlement will be taken by the transferee-spouse with the carry-over basis. This is the same as the transferor’s basis in the property). This carry-over basis rule applies to all property received by way of gift. As mentioned above, the rules for transfers to a Non-Resident Alien Spouses differ and carry-over basis rule would not apply. The recipient spouse should be viewed as releasing marital rights or other valuable consideration in exchange for the property received, with the result that the recipient will take a basis equal to the fair market value of the property received.
Divorces involving dual national couples when one is a non US citizen require extra care and attention.