When couples divorce, their property is generally split equally between them. But often, the couple has a balance sheet that doesn’t easily divide. If one spouse wants to keep more assets than the other, and has no source of funds to equalize the division, he will give his spouse a promissory for the difference. The note is for the amount of the amount needed to equalize the division of property, and usually provides for payments of principal plus interest at a reasonable rate.
A recent court case clearly has established that the interest paid to the ex-spouse is taxable to her, even though the principal on the note is exempt from tax as a transfer incident to divorce (Gibbs, TC Memo 1997-196). So if the recipient has to pay tax on the interest, the paying spouse should receive a corresponding deduction on his income tax return, right? Not necessarily. Until recently, the IRS has ruled that divorce-related interest is non-deductible personal interest, and has disallowed any deduction for it.
Several court cases have sided with the taxpayer and against the IRS. John Seymour gave his wife Katherine a promissory note for $625,000 in exchange for her interest in their business and marital residence. The note was payable over ten years with 10% interest per year. The note was secured by a mortgage on the residence.
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For more information, contact the Family Law Offices of Renee M. Marcelle at (415) 456-4444, or online at http://www.familylawmarin.com/--