Publication 504
Divorced or Separated Individuals

For use in preparing 2002 Returns

Instruments Executed Before 1985

The following rules for alimony apply to payments under divorce or separation instruments executed before 1985.

Exception.   There are two situations where the rules for instruments executed after 1984 apply to instruments executed before 1985.

1. A divorce or separation instrument executed before 1985 and modified after 1984 to specify that the after-1984 rules will apply.
2. A temporary divorce or separation instrument executed before 1985 and incorporated into, or adopted by, a final decree executed after 1984 that:
   1. Changes the amount or period of payment, or
   2. Adds or deletes any contingency or condition.

If an exception applies, see Instruments Executed After 1984, earlier.

Alimony Requirements

A payment to or for a spouse under a divorce or separation instrument is alimony if the spouses do not file a joint return and the payment meets both of the following requirements.

1. It is based on the marital or family relationship.
2. It is not child support.

In addition, the spouses must be separated and living apart for a payment under a separation agreement or court order to qualify as alimony.

Payments of a fixed sum.   If you must pay a fixed sum in installments, your payments during the year that you treat as alimony cannot be more than 10% of the fixed sum. This limit applies to payments for the current year and payments in advance, but not to late payments for an earlier year.

However, do not treat any part of a late installment payment as alimony if the fixed sum was payable over a period ending 10 years or less from the date of the divorce or separation instrument.

Payments subject to contingencies.   Payments are not considered installment payments of a fixed sum if they are to end or change in amount on the happening of one or more of the following contingencies.

1. The death of you or your spouse.
2. The remarriage of your spouse.
3. A change in the economic status of you or your spouse.

The contingency may be either specified in your instrument or imposed by local law.

Marital or family relationship.   To be alimony, your payments must be based on your obligation, because of the marital or family relationship, to continue supporting your spouse. Any payment that does not arise out of that support obligation, such as the repayment of a loan, is not alimony.

Property settlement.   Payments are not based on your obligation to continue support if they are a settlement of property rights. However, even if a state court describes payments made under a divorce decree as payments for property rights, they are alimony if they are made to fulfill a legal support obligation and they otherwise qualify.

Child support.   A payment that is specifically designated as child support under your divorce or separation instrument is not alimony. If the instrument calls for payments that otherwise qualify as alimony and does not separately designate an amount as child support, all the payments are alimony. This is true even if the payments are subject to a contingency relating to your child.

Example.   Your divorce decree states that you must pay your former spouse $400 a month for life for the support of your former spouse and your child. The payment is to be reduced to $300 upon the first of the following to happen: the child's death, the child's 22nd birthday, or the child's marriage. Despite these contingencies, no amount of child support is fixed by the decree. The entire payment is alimony.

Alimony Trusts, Annuities,
and Endowment Contracts

If you transferred property to a trust or bought or transferred an annuity or endowment contract to pay the alimony you owe, the trust income or other proceeds that would ordinarily be includible in your income must be included in your former spouse's income as alimony received. You do not include the payments in your income, nor can you deduct them as alimony paid. This rule applies whether the proceeds are from the earnings or the principal of the transferred property. It does not apply to any trust income that is fixed for child support.

Example.   You must make monthly alimony payments of $500. You bought your former spouse a commercial annuity contract paying $500 a month. Your former spouse must include the full amount received under the contract in income, as alimony. It does not matter whether the amount is paid out of principal or interest. You do not include any part of the payment in your income, nor can you deduct any part.

Annuity and endowment contracts.   Proceeds from annuity and endowment contracts bought for or transferred to a spouse after July 18, 1984, cannot be treated as alimony. However, this does not apply to contracts bought or transferred to pay alimony under a divorce or separation instrument executed before July 19, 1984, unless both spouses choose to have it apply.

Proceeds not alimony.   If the proceeds from an annuity or endowment contract cannot be treated as alimony, the amount received is reduced by the cost of the contract. Get Publication 575, Pension and Annuity Income, for information on reporting annuities, and Publication 525, Taxable and Nontaxable Income, for information on reporting endowment proceeds.

If the proceeds from a trust cannot be treated as alimony, see the rules for reporting trust income in Publication 525.

Qualified Domestic
Relations Order

A qualified domestic relations order (QDRO) is a judgment, decree, or court order (including an approved property settlement agreement) issued under a domestic relations law that:

1. Relates to the rights of someone other than a participant to receive benefits from a qualified retirement plan (such as most pension and profit-sharing plans) or a tax-sheltered annuity,
2. Relates to payment of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of the participant, and
3. Specifies the amount or portion of the participant's benefits to be paid to the participant's spouse, former spouse, child, or dependent.

Benefits paid to a child or dependent.   Benefits paid under a QDRO to the plan participant's child or dependent are treated as paid to the participant. For information about the tax treatment of benefits from retirement plans, see Publication 575.

Benefits paid to a spouse or former spouse.   Benefits paid under a QDRO to the plan participant's spouse or former spouse generally must be included in the spouse's or former spouse's income. If the participant contributed to the retirement plan, a prorated share of the participant's cost (investment in the contract) is used to figure the taxable amount.

The spouse or former spouse can use the special rules for lump-sum distributions if the benefits would have been treated as a lump-sum distribution had the participant received them. For this purpose, consider only the balance to the spouse's or former spouse's credit in determining whether the distribution is a total distribution. See Lump-Sum Distributions in Publication 575 for information about the special rules.

Rollovers.   If you receive an eligible rollover distribution under a QDRO as the plan participant's spouse or former spouse, you may be able to roll it over tax free into a traditional individual retirement arrangement (IRA) or another qualified retirement plan.

For more information on the tax treatment of eligible rollover distributions, see Publication 575.

Individual Retirement
Arrangements

The following discussions explain some of the effects of divorce or separation on traditional individual retirement arrangements (IRAs). Traditional IRAs are IRAs other than Roth or SIMPLE IRAs.

Spousal IRA.   If you get a final decree of divorce or separate maintenance by the end of your tax year, you cannot deduct contributions you make to your former spouse's traditional IRA. You can deduct only contributions to your own traditional IRA.

IRA transferred as a result of divorce.   The transfer of all or part of your interest in a traditional IRA to your spouse or former spouse, under a decree of divorce or separate maintenance or a written instrument incident to the decree, is not considered a taxable transfer. Starting from the date of the transfer, the traditional IRA interest transferred is treated as your spouse's or former spouse's traditional IRA.

IRA contribution and deduction limits.   All taxable alimony you receive under a decree of divorce or separate maintenance is treated as compensation for the contribution and deduction limits for traditional IRAs.

More information.   For more information about IRAs, including Roth IRAs, see Publication 590.

Property Settlements

There is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of a divorce. You may, however, have to report the transaction on a gift tax return. See Gift Tax on Property Settlements, later. If you sell property that you own jointly to split the proceeds as part of your property settlement, see Sale of Jointly-Owned Property, later.

Transfer Between Spouses

No gain or loss is recognized on a transfer of property from you to (or in trust for the benefit of):

• Your spouse, or
• Your former spouse, but only if the transfer is incident to your divorce.

This rule applies even if the transfer was in exchange for cash, the release of marital rights, the assumption of liabilities, or other considerations.

However, this rule does not apply if your spouse or former spouse is a nonresident alien. Nor does it apply to certain transfers covered under Transfers in trust, later.

The term property includes all property whether real or personal, tangible or intangible, or separate or community. It includes property acquired after the end of your marriage and transferred to your former spouse. It does not include services.

Medical savings accounts (MSAs).   If you transfer your interest in an Archer MSA to your spouse or former spouse under a divorce or separation instrument, it is not considered a taxable transfer. After the transfer, the interest is treated as your spouse's Archer MSA.

Incident to divorce.   A property transfer is incident to your divorce if the transfer:

1. Occurs within one year after the date your marriage ends, or
2. Is related to the ending of your marriage.

A divorce, for this purpose, includes the ending of your marriage by annulment or due to violations of state laws.

Related to the ending of marriage.   A property transfer is related to the ending of your marriage if both the following conditions apply.

1. The transfer is made under your original or modified divorce or separation instrument.
2. The transfer occurs within 6 years after the date your marriage ends.

Unless these conditions are met, the transfer is presumed not to be related to the ending of your marriage. However, this presumption will not apply if you can show that the transfer was made to carry out the division of property owned by you and your spouse at the time your marriage ended. For example, the presumption will not apply if you can show that the transfer was made more than 6 years after the end of your marriage because of business or legal factors which prevented earlier transfer of the property and the transfer was made promptly after those factors were taken care of.

Transfers to third parties.   If you transfer property to a third party on behalf of your spouse (or former spouse, if incident to your divorce), the transfer is treated as two transfers.

1. A transfer of the property from you to your spouse or former spouse.
2. An immediate transfer of the property from your spouse or former spouse to the third party.

You do not recognize gain or loss on the first transfer. Instead, your spouse or former spouse may have to recognize gain or loss on the second transfer.

For this treatment to apply, the transfer from you to the third party must be one of the following.

1. Required by your divorce or separation instrument.
2. Requested in writing by your spouse or former spouse.
3. Consented to in writing by your spouse or former spouse. The consent must state that both you and your spouse or former spouse intend the transfer to be treated as a transfer from you to your spouse or former spouse subject to the rules of section 1041 of the Internal Revenue Code. You must receive the consent before filing your tax return for the year you transfer the property.

Transfers in trust.   If you make a transfer of property in trust for the benefit of your spouse (or former spouse, if incident to your divorce), you generally do not recognize any gain or loss.

However, you must recognize gain or loss if, incident to your divorce, you transfer an installment obligation in trust for the benefit of your former spouse. For information on the disposition of an installment obligation, see Publication 537, Installment Sales.

You also must recognize gain on the transfer of property in trust in the amount by which the liabilities assumed by the trust, plus the liabilities to which the property is subject, exceed the total of your adjusted basis in the transferred property.

Example.   You own property with a fair market value of $10,000 and an adjusted basis of $1,000. The trust did not assume any liabilities. The property is subject to a $5,000 liability. Your recognized gain on the transfer of the property in trust for the benefit of your spouse is $4,000 ($5,000 - $1,000).

Reporting income from property.   You should report income from property transferred to your spouse or former spouse as shown in Table 3.

For information on the treatment of interest on U.S. savings bonds, see chapter 1 of Publication 550, Investment Income and Expenses.

Table 3. Property Transferred Pursuant to Divorce The tax treatment of items of property transferred from you to your spouse or former spouse pursuant to your divorce is shown below.

When you transfer property to your spouse (or former spouse, if incident to your divorce), you must give your spouse sufficient records to determine the adjusted basis and holding period of the property on the date of the transfer. If you transfer investment credit property with recapture potential, you also must provide sufficient records to determine the amount and period of the recapture.

Tax treatment of property received.   Property you receive from your spouse (or former spouse, if the transfer is incident to your divorce) is treated as acquired by gift for income tax purposes. Its value is not taxable to you.

Basis of property received.   Your basis in property received from your spouse (or former spouse, if incident to your divorce) is the same as your spouse's adjusted basis. This applies for determining either gain or loss when you later dispose of the property. It applies whether the property's adjusted basis is less than, equal to, or greater than either its value at the time of the transfer or any consideration you paid. It also applies even if the property's liabilities are more than its adjusted basis.

This rule generally applies to all property received after July 18, 1984, under a divorce or separation instrument in effect after that date. It also applies to all other property received after 1983 for which you and your spouse (or former spouse) made a section 1041 election to apply this rule. For information about that election, see section 1.1041-1T(g) of the regulations.

Example.   Karen and Don owned their home jointly. Karen transferred her interest in the home to Don as part of their property settlement when they divorced last year. Don's basis in the interest received from Karen is her adjusted basis in the home. His total basis in the home is their joint adjusted basis.

Property received before July 19, 1984.   Your basis in property received in settlement of marital support rights before July 19, 1984, or under an instrument in effect before that date (other than property for which you made a section 1041 election) is its fair market value when you received it.

Example.   Larry and Gina owned their home jointly before their divorce in 1978. That year, Gina received Larry's interest in the home in settlement of her marital support rights. Gina's basis in the interest received from Larry is the part of the home's fair market value proportionate to that interest. Her total basis in the home is that part of the fair market value plus her adjusted basis in her own interest.

Property transferred in trust.   If the transferor recognizes gain on property transferred in trust, as described earlier under Transfers in trust, the trust's basis in the property is increased by the recognized gain.

Example.   Your spouse transfers property in trust, recognizing a $4,000 gain. Your spouse's adjusted basis in the property was $1,000. The trust's basis in the property is $5,000 ($1,000 + $4,000).

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