Belot v. Comm’r, T.C. Memo. 2016-113, 2016 WL 3248031 (2016)
Facts: During their marriage, the parties operated a dance studio. The business consisted of an S corporation which was the actual studio, an LLC which operated a boutique selling dance clothing, and another LLC which owned the real estate on which the studio operated. The parties owned each of these entities in different percentages.
The parties were divorced in New Jersey in 2007. The decree incorporated an agreement signed by the parties, in which they agreed to convey interests in the entities so that each of them owned 50% of all three entities. The decree therefore left the divorcing parties as joint owners of the business.
Later in 2007, the wife filed a complaint against the husband, alleging that he had mismanaged the studio, and seeking to remove him as director and employee. This action was settled in 2008 by an agreement, in which the wife agreed to buy the husband’s interest in the business for $900,000 to be paid at closing, and $680,000 to be paid over 10 years.
The husband filed tax returns which claimed that the sale of the business under the 2008 agreement was a § 1041 exchange. When the IRS assessed a deficiency, the husband then appealed to the Tax Court.
Issue: Was the transfer required by the 2008 agreement a 1041 exchange?
Answer to Issue: Yes
Summary of Rationale: The IRS relied upon Reg. § 1.1041-1T(b), Q&A-7, which provides: