When dividing assets in divorce individuals, mediators and attorneys alike, tend to focus on the property division spreadsheet. The current values of asset and debt balances determined to be marital are outlined. Typically, above all else, the focus and end goal is to split property 50-50. With so much emphasis on this spreadsheet that dictates the remainder of your financial future, is there anything missing that could dramatically change your post-divorce experience?
In most divorces, the largest asset involved tends to be the home and therefore carries a plethora of questions regarding equity and living arrangements moving forward. The bulk of planning efforts focus on basic budgeting and are driven from an emotional perspective of either an intense feeling of wanting to keep the home, run from it or utter confusion. Regardless of whether you wish to stay in the home or establish a new living space by renting or purchasing a new home, it would be remiss to rely solely on the real estate value listed on the property division worksheet, basic budgeting applications and not consider the following:
Part 3: Home Equity and Future Living Arrangements
Capital Gains Tax
Capital gains taxes are assessed when a home is sold. Therefore, when one partner refinances and stays in the home, future taxes are overlooked during the divorce process as all eyes are focused on the equity numbers listed on property division worksheet. When the home is sold post-divorce an exclusion is available for up to $500,000 for married couples or $250,000 for individuals as long as the home has been owned and used as a primary residence for two out of the last five years. The equity growth and potential capital gains tax involved, especially for longer marriages, can be significant down the road if a spouse stays in the home and can only utilize the lower individual exclusion.
For example, if Anne wishes to stay in the home where she raised her kids for the passed 18 years that was purchased for $150,000 and is now worth $750,000, upon sale of the home (assuming no additional growth in value) she would experience a $600,000 gain. If she refinanced the home into her sole name and remains unmarried, Anne would qualify for a $250,000 exclusion leaving her with a taxable gain of $350,000. Capital gains are most often taxed at a rate of 15% which would amount to an additional tax bill of $52,500 when the home is sold – a large financial burden to deal with for an individual! Keep in mind that if there is additional equity growth in the home, the tax will be even larger.
Mortgage Lending Requirements
Many couples finalize their divorce without integrating mortgage lending requirements into their settlement which can close doors for intended plans post-divorce. Debt to income and loan to value ratios are directly affected by equity payout agreements and support payments that are nearly impossible to change for mortgage lending purposes after a divorce has been finalized. To qualify as income, spousal and child support payments must meet specific time guidelines. These issues don’t affect the property division worksheet directly, however, post-divorce changes affect the financial strategy within the property division worksheet. Read Part 1: Retirement Accounts and Part 2: Non-Retirement Accounts in this series for more information and examples.
On-Going Maintenance and Taxes
Regardless of if you are planning on staying in your home or purchasing a new home, a home inspection is recommended. This report provides a full picture of the condition of the home, outlining serious issues that might require substantial financial outlays as well as other problems that should be addressed causing a financial impact down the road.
As real estate values continue to climb, property taxes continue to rise. If you are looking for long-term living arrangements post-divorce it is important to leave a large enough margin in your budget to adjust for possible tax increases and home maintenance whether it is expected and listed on an inspection report or an unforeseen emergency - don't overlook the importance of an emergency fund and how to manage replenishing it.
Establishing living arrangements for moving forward is complex and requires more analysis and planning then exclusively relying on a 50-50 division of property concept. Be sure to evaluate all the financial components of your divorce transition; how they affect your priorities and long-term financial situation. Financial education, analysis and proper planning before signing the final papers is more important than ever to build a strong foundation for the next chapter in life.
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Disclosure: Divorce transition/financial planning services offered by A.M. Financial. Investment advisory services offered through WealthSource Partners, LLC ("WSP"). A.M. Financial and WSP are independent and unaffiliated entities. The statements and opinions expressed are those of A.M. Financial and Amy Mahlen and do not represent the views and/or opinions of WSP or any other associated or affiliated person of WSP. Furthermore, the statements and opinions expressed are for informational and educational purposes only and should not be construed as legal, tax, accounting or investment advice. All statements and opinions are current only as of the time made and are subject to change without notice.