FEDERAL INCOME TAX; INCOME; RECOGNITION OF GAIN; SALE OF RESIDENCE: Taxpayer who failed to close on purchase of a new residence within two years after sale of prior residence cannot defer gain under Section 1034(a, even where taxpayer has binding contract and has taken possession within the two year period. Waters v. Commissioner, T.C. Memo. 1995-535.

Although the taxpayer had made the initial deposit and moved into new residence prior to expiration of two-year period, the sale was not yet complete under state (California) law and taxpayer had not yet assumed the burdens and benefits of ownership.

FEDERAL INCOME TAX; RECOGNITION OF GAIN; SALE OF RESIDENCE; DIVORCE: Divorced taxpayer who obtains undivided ownership of residence is liable for the total amount of gain upon the sale of the property. Wells v. Commissioner, T.C. Memo. 1995-537.

Spouse argued that the house was still community property, and that she shared liability for the gain with her (now ex) husband. According to the court, under California community property law, the taxpayer's husband "transmuted" their community property interest in the home into his wife's sole ownership when he executed a quitclaim deed. At the time of the deed, the parties were not formally divorced, but were separated. The husband's lawyer delivered the deed to the wife's lawyer, but it was not recorded. One year later, wife recorded the deed and sold the property, still prior to the divorce.

Held: Wife was sole owner of the home. She was therefore liable for the entire gain.

There is another side to the story. The husband executed the quitclaim deed on the same day that the parties jointly refinanced the home. $30,000 of the refinancing proceeds were used to pay the husband's outstanding tax liabilities (apparently separate liabilities). The deed was delivered to the wife's attorney, but was not recorded. Subsequently, both parties participated in the marketing of the house, including their jointly signing the listing agreement. Husband deducted interest he paid on the mortgage as home mortgage interest. Apparently, the parties fell out over the marketing of the house, and wife's attorney recorded the quitclaim deed, so that wife "could have control" over the marketing of the house. The husband, in contemporaneous letters to the wife's attorney, protested the recording of the deed, arguing that it had been "conditionally delivered," and that the husband had not consented to recording it.

According to the tax court, the ultimate property settlement, which occurred after the sale of the house, treated the house proceeds as the wife's separate property.

California law at the time presumed that property acquired by the spouses during marriage was community property, regardless of who held title. The question here was whether the husband's quitclaim deed "transmuted" the property to the wife's separate property. The court focussed on the fact that the language of the deed was "unequivocal," even though it did not state that the wife held the home as her "sole and separate" property." It makes no effort to respond to the wife's argument that the husband had never actually "delivered" the deed, focussing instead on the evidence of the subsequent property settlement.

Comment: It is difficult to comment upon the "rightness" or "wrongness" of the outcome, since we lack many critical facts. But from an analytic standpoint, it would seem dangerous to treat a quitclaim deed delivered conditionally to the wife's lawyer as a formal delivery, and not even "voidable."

Further, if the parties, for matters of their own convenience, desired to have one party hold title to the property, even though it was still community property, the device of a quitclaim deed would be quite appropriate for this purpose. Consequently, when there are no third party bfp interests at stake, it seems inappropriate to rely entirely on the execution of the deed as emblematic of the parties' intent to transmute, especially when contemporaneous evidence suggested a different intent. Parties who truly desire to convey title usually see to it that the deed is promptly recorded. The one year delay in recording, coupled with the parties' joint listing agreement and the husband's other activities, suggest an intent other than a transfer of title to the wife.

The court is vague about the property settlement details, but if, by the sale, the husband avoided liability on the refinancing mortgage, which was used in part to finance payment of his separate debts, then he may have received considerable benefit from the equity in the house even though he got none of the cash proceeds.

For a different slant on these issues, see: Marsha Hatch Ingham v. United States, 77 AFTR2d Par. 96-409 No. C95-578R. 96 TNT 31-8. (Wife received title to property under divorce decree, subject to obligation to sell the ground within five years and repay to ex-husband his share of community property interests. In fact, she sold house within four months. IRS took the position that sale was for benefit of ex-husband, and did not qualify for non-recognition when wife acquired another home. Tax court held that the divorce decree was "ambiguous," that it was entitled to rely upon context, and concluded that wife had adduced sufficient evidence to show that she was qualified as owner, and could get non-recognition.)

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