A client sat across from me last year, pleased with himself. He had agreed to let his wife keep the savings account all in cash, and he would keep the house and the brokerage account. Both he and his wife would receive about two million dollars on paper. Even split, he thought. It was not. He was walking away with a built-in tax bill of several hundred thousand dollars for the house that they bought 25 years ago and the brokerage account that held stocks also purchased 20 years ago. Both of his assets had increased significantly in value and there would be huge capital gains. She had no capital gains. He had no idea until I showed him the math.
This is one of the most expensive misunderstandings in high net worth divorce. Two assets can carry the identical number on a Statement of Net Worth and be worth wildly different amounts in your hand after you sell them. If you divide by the face value alone, one spouse quietly absorbs a tax liability the other never touches. The paper looks fair. The outcome is not.
Here is what is actually happening, and how to protect yourself from it.
Tax Basis Is the Number That Matters
Every capital asset has a basis. In plain terms, the basis is what you paid for it, sometimes adjusted for improvements or reinvested dividends. When you sell, you pay capital gains tax on the difference between the sale price and the basis, not on the full sale price.
So consider two brokerage accounts, each worth one million dollars today. The first holds stock purchased fifteen years ago for two hundred thousand dollars. The second holds stock purchased last year for nine hundred and fifty thousand dollars. Same value on paper. But the first account carries an eight hundred thousand dollar unrealized gain, and the second carries almost nothing. Whoever takes the first account inherits the tax. At current federal long term capital gains rates, plus the net investment income tax, plus New York State income tax, that liability can run past two hundred and fifty thousand dollars. The person who took the “equal” account is a quarter of a million dollars poorer, and it will not show up until they sell.
This is why I never let a client agree to a division based on account values alone. We look at the basis, holding period, and the after tax value of every significant asset before anyone signs anything. This kind of asset by asset scrutiny is part of any serious approach to equitable distribution in New York.
The Transfer Is Tax Free. The Sale Is Not.
There is a rule that gives people a false sense of security. Under Internal Revenue Code Section 1041, transfers of property between spouses incident to a divorce are not taxable events. You can move the brokerage account, the house, the interest in the partnership, from one spouse to the other, and no tax is due at the moment of transfer.
People hear that and relax. They should not. Section 1041 does not erase the tax. It defers it, and it hands the receiving spouse the original basis along with the asset. You take the stock, you take the gain that came with it. The bill arrives later, when you sell, and by then your former spouse is long gone and under no obligation to share it.
I have seen the nasty version of this play out. A spouse fights hard to keep the appreciated asset because the number looks good, then sells two years later and discovers that a third of the “value” belonged to the government all along.
Where This Bites Hardest in a High Net Worth Case
At the high end, the marital estate is rarely just a house and a 401k. It is a concentrated, appreciated, complicated collection of assets, and almost every one of them carries a basic problem.
Concentrated stock positions and long held brokerage accounts are the obvious ones. Executive compensation such as restricted stock units adds its own layer, because the tax treatment on vesting interacts with the capital gains treatment on later sale. The marital residence carries its own capital gains exposure, and the timing of the sale relative to the divorce determines whether you can still claim the primary residence exclusion. A closely held business, once sold, can generate a very large gain measured against a very low basis.
None of this is a reason to avoid taking a particular asset. It is a reason to price it correctly. An appreciated asset is not worthless, it is simply worth less than its face value, and the settlement has to reflect that. Sometimes the right move is to divide each asset class in kind, so both spouses share the embedded gain proportionally. Sometimes it is to trade a low basis asset against a high basis one and adjust the numbers so the after tax values actually match. That analysis belongs to your attorney and your tax professional working together, not to a rough split at the kitchen table.
Supreme Court, Not Family Court
One point that trips people up in New York. The financial issues in a divorce, equitable distribution of the marital estate, the treatment of appreciated assets, the structuring of a settlement around tax exposure, are handled in the Supreme Court, which is the trial level court that hears divorce in New York. Family Court does not grant divorces or divide marital property.
If your case involves substantial assets with real tax consequences, you are in the Supreme Court, and you want counsel who litigates financial issues at that level. Every one of these assets also has to be disclosed on your sworn Statement of Net Worth, which is where the analysis begins.
What This Means Before You Sign
The instinct to divide everything down the middle and be done with it is understandable. In a high net worth case it is also dangerous. A settlement that looks perfectly equal on the Statement of Net Worth can leave one spouse hundreds of thousands of dollars or more behind once the tax bills come due.
Before you agree to anything, insist on three things. Know the basis of every significant asset. Know the after tax value, not just the face value. And structure the division so that the tax burden is shared, not silently dumped on one side.
Getting this right is not about paying less tax than you owe. It is about making sure you are not handed a liability disguised as an asset. The time to run these numbers is before the agreement is signed, because once it is executed, the math is yours to live with.
If you are facing a divorce with a complex financial picture, contact a trusted attorney and of course, take a look at my blog lisazeiderman.com for more information on various divorce subjects.
The information in this article is for general educational purposes only and does not constitute legal advice. Please consult a qualified New York divorce attorney and tax professional regarding your specific circumstances.