What About the House? Understanding the Issues in Divorce and Property Division
When spouses divorce, “what to do with the family home” often forms a huge part of settlement negotiations. Should it be sold and the proceeds split? Should one partner keep it? In order to make the best decision, couples need both legal and financial advice on dealing with a house in divorce, because allowing emotions alone to drive the choice could end up leaving one party in an untenable financial position.
Here are some of the questions that came up in discussion with senior wealth manager Jeff Abadie.
- Can I legally retain the primary home in a divorce settlement, and if so, can I afford it?
- What are the pros and cons of retaining the house that I should be considering?
- If someone is trading assets for the house in a settlement negotiation, how do they know which are the best—or worst—for them to trade for?
- When beginning the process of a divorce, when is the best time to involve both an attorney and a financial advisor?
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Can I legally retain the primary home in a divorce settlement, and if so, can I afford it?
This is probably the biggest question we get asked in any divorce when there is a house. Typically one party wants to stay, perhaps because they want continuity for the children or they have a separate property down payment in the house. We find that when the real estate market is strong and the house is rising in value, people are more likely to want to stay; when its value is decreasing, they’re more interested in creative options for being bought out by their partner.
If one party wants to keep the house, the first step is to determine what the equity is by getting a fair market evaluation. Subtracting the mortgage plus any second mortgage or HELOC from the appraised value will determine that figure. I like to bring in a financial planner to go over the numbers with my client to determine if they can afford to keep the property and whether the rest of the settlement can be structured to support that.
Cash flow planning will help determine if ongoing expenses like the mortgage, property taxes, and upkeep can be reasonably met. Financial calculations also need to take into account closing costs, potential tax consequences, and other considerations. It comes down to a cost-benefit analysis—given that you will need to buy your former partner out of their equity in the house, will holding on to the property be the best option for you?
What are the pros and cons of retaining the house that I should be considering?
On the pro side, keeping the home results in less instability and disruption in a time when there is plenty of both. Real estate also tends to appreciate over time, so there can be significant financial benefit if you live in the home long term. It may also be that selling a home and buying into a new, more expensive market may not be as ideal.
One cost you need to consider is the potential tax consequence when you sell the house down the road. An individual can deduct $250,000 in capital gains when selling a house, but if the house is sold when you’re still married that deduction is doubled. The possible impact of capital gains taxes through the loss of that deduction is something many people don’t factor into the whole analysis.
Another problem we see is that often the only other large asset a person has to buy the spouse out is a 401K or an IRA. There are immediate and specific tax consequences to taking an early withdrawal from a retirement account, including penalties and having to pay regular income taxes on the withdrawal, which are much easier to determine than trying to estimate the tax consequences of a future sale. It is difficult to compare the two.
If the plan is only to keep the house a short time, you could find yourself selling into a down market. In addition, refinancing the mortgage to update the title to a sole owner can have huge impacts if the person doesn’t qualify, or if interest rates are much higher than when the original mortgage was put in place.
Generally speaking, if the plan is to remain in the home for a very long period and income can support the house, there’s a strong argument that keeping the house would make sense. If that isn’t the case, then you need to take a hard look to see if keeping it will have the benefit you’re hoping for.
If someone is trading assets for the house in a settlement negotiation, how do they know which are the best—or worst—for them to trade for?
I prefer to defer that question to whoever my client is working with as a financial planner. The answer really depends on many different factors, such as where they are in their career, where they are health-wise, whether they have other investments, whether they have other income, if they are retiring soon, if the house is old versus new, what kinds of assets are involved, etc. It is best to work in tandem with the financial planner to come up with the best long-term solution for a client’s individual situation.
When beginning the process of a divorce, when is the best time to involve both an attorney and a financial advisor?
There are basically three steps in the divorce process. First is starting the divorce. The second is the “show me your cards” stage, when we start talking about the assets and debts that are there. This is the most difficult stage, but it is also where we figure out the third stage, the judgment, which solidifies how the marital property is divided, tax consequences, etc.
A financial planner, CPA, or whoever my client is comfortable working with should be brought in at that second stage, fairly near the beginning—in the first month if not sooner. A financial planner can also be useful after the settlement is agreed upon, to help ensure that it is executed as intended and that key steps such as updating beneficiaries, are not overlooked.
Get Help Navigating Property Division in Divorce in California
When you divorce, your property settlement forms the material basis for your future. Hart Ginney LLP can help defend your rights, provide legal guidance, and work with your financial advisor to create the appropriate settlement for your situation. To get in touch, click to call us (510) 628-0250 or fill out the form below today.