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Why You Don’t Want the House in the Divorce

Date: July 15, 2014      Publication: Bottom Line Personal      Source:  Diane Pearson, CFP, CDFA, Legend Financial Advisors      Print:

And Other Assets That Aren’t Worth As Much As You Think

Be very careful how you split up the possessions if you split up with your spouse. Accepting certain assets in a divorce settlement could leave you with a smaller slice of the total pie than you deserve. You can’t necessarily depend on your divorce attorney to warn you about all these potential potholes, either—most divorce attorneys are experts on family law, not asset values. And your financial adviser may not understand divorce law.

Six types of assets that you may not want in a divorce settlement…

The family home. Some people desperately want to keep their homes in a divorce. This may be where they raised their kids. It’s where they know their neighbors. It’s where they expected to grow old. It’s only natural to want to maintain these emotional connections as a marriage crumbles—but taking the home in a divorce settlement usually is a big financial mistake.

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Homes typically are worth hundreds of thousands of dollars. To keep this asset in a divorce, you probably would have to agree to let your partner keep the lion’s share of the family’s retirement savings and/or other investments. But while that investment portfolio is likely to increase significantly in value over the years and produce much needed retirement income, a home is more likely to stagnate in value and perhaps even be a financial sinkhole.

Don’t be fooled by the recent real estate recovery—homes simply are not good investments. From 1890 through 2012, on average, home prices gained absolutely nothing in value after adjusting for inflation. Owning a home actually costs money—lots of it. In addition to mortgage payments, home owners must pay thousands of dollars each year in property taxes and insurance, maintenance and utility bills.

Most divorced people are much better served by agreeing to sell the family home during the divorce process. Buy or rent a smaller home, possibly an affordable condo or apartment, instead. (Or let your partner keep the house if he/she likes, while you get the lion’s share of the savings.)

Tax-deferred retirement accounts. When is $100,000 in savings not worth $100,000? When there’s a big tax bill due. Unlike most other types of savings, assets held in tax-deferred accounts such as traditional IRAs or 401(k)s are taxed as income when the money is withdrawn. That means perhaps one-fifth to one-third or more of the savings might wind up in the government’s pockets, not yours, depending on your federal and state income tax brackets.

Tax-deferred retirement savings may be illiquid, as well—you might face a 10% penalty if you withdraw any money from these accounts prior to age 59½.

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In a divorce settlement, don’t agree to take more than half of the tax-deferred assets, which eventually will be taxable, if that means your soon-to-be ex gets more than half of the Roth IRA savings, which typically won’t be taxed, or more than half of the non-tax-advantaged savings. Exception: You get more assets to make up for the future tax bite.

Investments that have gained a lot in value. Which would you rather receive in your divorce settlement—$100,000 worth of a stock that has climbed steadily in value since you purchased it…or $100,000 worth of a stock that has lost money for your portfolio? Intuitively it might seem wise to take the stock that has done well, because it’s more likely than the laggard to continue to increase in value. But that’s the wrong choice, and doing that could leave you saddled with a big tax bill.

When you sell an investment that you have owned for more than one year, any increase in its value from its cost basis—what it cost you—is taxed at your long-term capital gains tax rate, which currently is 15% for most taxpayers. (Taxpayers in the 39.6% income tax bracket pay a steeper 23.8% rate when the new net investment income tax is included. Profits from the sale of assets held less than one year are taxed at a taxpayer’s income tax rate.) On the other hand, selling an investment that has lost money can decrease your income tax bill.

Don’t agree to take your portfolio’s winning stocks in a divorce settlement while your former spouse takes the losers unless you receive a larger share of the total assets to make up for your future tax bill. A few exceptions…

Cost basis doesn’t matter if an investment is held in a tax-advantaged retirement account. Whether or not they have gained value, investments held in tax-deferred accounts are taxed as ordinary income when withdrawn, while those held in Roth accounts typically are not taxed at all upon withdrawal.

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Low cost basis isn’t a problem if you intend to leave the asset to your heirs. In fact, it can be an advantage to the family, because assets such as stocks that aren’t held in tax-advantaged accounts generally receive a “step up in basis” upon your death. That means the capital gains up to that point are not taxed when the assets are later sold by your heirs.

You don’t have to pay long-term capital gains taxes if you are in the 15% income tax bracket or below. As of 2014, single filers with taxable income of up to $36,900 qualify for this tax bracket. These rules could change in future years.

Art, antiques and collectibles. An appraiser typically is hired or a guidebook consulted during the divorce process to determine the value of any art, antiques and collectibles. Trouble is, the values these appraisers and guidebooks assign to these possessions often are much too high. The quoted amount is often what you would have to spend to buy a similar item in a shop, rather than the amount you would receive if you sold the one you have. Because of steep retail markups, these figures can be different.

Art, antiques and collectibles can be costly to insure. And if they eventually are sold for more than they initially cost, you might face a long-term capital gains tax of 28%.

If you don’t want to give up your art, antiques or collectibles in a divorce, at least confirm that the appraiser or guidebook used will provide the amount your items would bring if you sold them, not their replacement or insurance value.

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A small business (unless you know as much as or more than your spouse about the business and its finances). Be very wary if your spouse suggests that you take the business in a divorce settlement if that spouse handles the finances. He/she might have good reason to believe that the company is worth less than its appraised value. Example: Maybe your spouse knows that a key client is about to defect to a competitor.

Relatively new annuities. Cashing out an annuity too soon (generally within five to 12 years of the date when it was purchased) could trigger a surrender fee of as much as 8% to 10%. Many annuities also have steep annual fees that can cut into their long-term value.

Source: Diane Pearson, CFP, CDFA, personal chief financial officer at Legend Financial Advisors, Inc., Pittsburgh. She has been included in Worth magazine's annual list of the country's top 250 wealth advisers four times. As a certified divorce financial analyst, she has helped hundreds of divorced people value their marital assets. Legend-Financial.com