Division of Property Can Lead to Tax Consequences
In life, there are moments when we have to deal with property matters or matters involving the division of property. Since upon the division of property the value of individual’s property does not change actually, it is often considered that tax consequences do not apply to divisions. In principle, we could say that this is true, however as we know, the essence is sometimes hidden between the lines. It is good if you are able to become aware of it before entering into any arrangements, so that you are not faced with any unexpected tax consequences later. You know the saying, forewarned is forearmed.
In practice, the division most commonly takes place as the division of real estate, where several co-owners have the right to property or as the division of matrimonial assets. Accordingly, in the following part the circumstances that can have an effect on tax consequences in either case will be outlined in more detail. In certain cases, they do not even arise, which is definitely most favourable for individuals and they are happy about it.
Such regulation does not apply to the division of matrimonial assets, which in principle does not lead to any tax consequences. The division of matrimonial assets is not deemed as legal transaction with things, as upon the division the ownership right on things does not pass from one person to the other, but rather until-now-common thing is divided. On a part of the divided thing, each of the existing common owners obtains an exclusive ownership right on a part of the divided thing. This applies also to civil division, which takes place when the physical division is not possible and one of the existing common owners receives the monetary value of its share instead of the thing. In the latter case, the division appears to be similar to sale, however if tax would be levied on such division, the balances that should have been achieved with the division between the parties, would be tilted. This way the civil division would not be equal to the physical division, the purpose of the division would not be achieved and one of the parties would be deprived of its legal right to obtain with the division of matrimonial property the amount of its share in the matrimonial property.
However, the said does not mean that each division of matrimonial property does not have any tax consequences. Namely, if it was established that civil division has led to a disproportionate division, it could be deemed that the sale took place only in the part exceeding the party’s share in the matrimonial property. For instance, if the spouses were each entitled to a half of the matrimonial property and the division would be carried out in a manner that one would receive more and the other one less, it could be deemed for tax purposes that the difference constitutes a taxable transaction. Similar applies to the case when disproportionate division would be carried out with the purpose of avoiding the conclusion of another type of arrangement (e.g. sale or gift). In both cases, tax consequences would arise.
The same tax effects can arise upon the division of real estate owned by several co-owners. Upon the division of such real estate, a distinction should be made between two situations. When joint ownership is divided in nature in such manner that new real properties are created (e.g. with land subdivision) and each co-owner becomes the sole owner of the new plot, such division is not subject to taxation. Of course only if the division is in proportion to the value of the co-ownership share so that each receives such value equalling the value of its joint ownership before the division. If someone received a higher value, the surplus would be subject to taxation.
For many years, a different rule applied in the case when two co-owners co-owned several real properties and divided joint property in such manner that each of them received some of these real properties, more precisely according to their co-ownership share. Such transactions were subject to taxation, since it was deemed that the co-ownership share on one real property was replaced by the co-ownership share on another real property, whereby the exchange (sale) of real properties was supposed to take place. In accordance with the most recent practice, such transactions are no longer subject to taxation.
Nevertheless, taxation still applies when the co-owners divide real properties in such manner that some of them keep the entire real property, while paying out others (either in cash or with another real property or share in real property). In such case, it is deemed in terms of taxes, that a taxable transfer of real property took place.
To conclude, the following is noteworthy. If an arrangement on the division was concluded and tax would be levied from it, which the parties did not expect and would not want to pay it, it will not always be possible to rectify the actual state in the tax area with a possible cancellation of agreement. Namely, in terms of taxes, cancellation may be deemed as a new transaction, which is again subject to taxation.
Thus, the maxim “think twice, act once” is the one offering us security and protecting us from the arrangement in relation to which an unexpected tax obligation could occur.