Section 1041 does not apply to property transfers that take place prior to marriage. Accordingly, practitioners need to be on the lookout for a release of marital rights by a fiancée in exchange for a pre marriage property transfer under the terms of a premarital agreement which would not qualify for Section 1041 and thus could potentially be viewed by the taxing authorities as a taxable transaction. In stark contrast, a property transfer in exchange for the release of martial rights taking place after the couple’s marriage under a premarital agreement falls within § 1041 and thus is non-taxable.
§1041 Applies to All Transfers to a Former Spouse within One Year of Divorce
Practitioners must be aware that under IRC § 1041(c)(1) and Reg. § 1.1041-1T(b), Q& A-6, apparently out of administrative convenience, any transfer that takes place within the first year after the marriage ends between ex-spouses will be governed by the 1041 non-recognition rules even where not factually related to the cessation of the marriage. Thus, IRC section 1041 non recognition provisions will apply even if the property that is transferred during the first year after marriage was acquired by solely the transferor out of separate property after the divorce was finalized. This can lead to unexpected tax results.
§1041 Can Reach Certain Transfers Made to Third-Parties
Section §1041 specifically addresses solely transfers of property between spouses and former spouses and certain trusts for H and W’s benefit. However, the temporary regulations expand the reach of Section 1041 to “certain” transfers of property made on behalf of a spouse or former spouse to a third party, as if the transfer was directly between spouses. A property transfer to a third party that is transferred on behalf of a spouse or former spouse will qualify for § 1041 treatment if one of the following three scenarios are on point as specified under Reg. § 1.1041-1T(c) and Q& A-9.
the third party transfer is mandated under a qualifying divorce instrument;
the third party transfer occurs following a written request of the transferee spouse; or
the transferor spouse obtains a timely written consent or ratification of the third-party transfer from the transferee spouse and must specifically state that the parties intend the transfer to be treated as a transfer between spouses qualifying under § 1041. The ratification will be considered timely if received by the transferor spouse before the filing of the transferor’s tax return for the tax year at issue.