The Gay Tax Shelter: Exploiting IRS Non-Recognition of Gay Marriage to Save Money
Gideon Alper publishes the Gay Couples Law Blog. The blog discusses new developments in same sex family law and estate planning. He lives in Atlanta, Georgia, and you can email him at firstname.lastname@example.org or follow him on twitter. These are his words…
When paying federal taxes, it can pay to be gay.
The IRS doesn’t recognize gay marriage because of the Defense of Marriage Act. Even if you’re officially married in one of the states that allows it, you still have to file as single for your federal taxes.
This unequal treatment, however, lets gay couples take advantage of their single-filer status by using tax-avoidance techniques that married straight couples, who have to file jointly, can’t use.
Today I’m going to focus on just one of these techniques: deferring the recognition of gain on the sale of your property.
What happens when you sell property
Normally, when you sell property, you have to recognize as income how much the property has increased in value. So if you buy a house for $50,000 and sell it later for $100,000, you must recognize and pay taxes on $50,000 of income.
Alternatively, you could sell the $50,000 house to someone who promises to pay you $100,000 in 10 years. In that case, you won’t have to recognize the income until the buyer pays you 30 years from now. This is called an installment sale.
Deferring income by selling to your spouse
A married couple might think to defer the recognition of gain on their property by combining these two ways of selling property.
Consider a married couple: Amy and Bob. Amy gives a house she bought for $50,000 to her husband Bob in exchange for a promise by Bob to pay Amy $100,000 in 30 years. Bob now owns the house.
Then, Bob sells the house (now worth $100,000) to some third party for $100,000 in cash. Bob has no income on this sale because he gave up something worth $100,000 (the house) in exchange for the same amount in cash.
Taken together, the couple has gotten rid of their $50,000 house for $100,000, but doesn’t have to recognize the $50,000 of income until 30 years from now.
Sound too good to be true? It is. The IRS prevents married couples like Amy and Bob from doing this kind of transaction. Specifically, the IRS doesn’t recognize any gain or losses in transactions between married couples.
So what actually happens is that when Amy gives Bob the house, Amy never reports any income on it, and Bob will own a house still worth $50,000, not $100,000. When Bob sells the house to that third party for $100,000, he must recognize $50,000 in income immediately. The end result is the same as if Amy had just sold the house herself to the third party.
But what if you’re a gay couple?
Gay couples can exploit the tax code to defer recognition of property gain. Because the IRS treats gay couples as unrelated people, the rules that prevent married couples from using the above technique don’t apply to them. Therefore, gay couples can structure their property transactions to defer income tax on any property one of them owns that has increased in value. In the $50,000 house example, the couple could sell the house for $100,000 without recognizing the $50,000 of income for years.
Photo credit: Gay Couples Law Blog.