Keeping the Family Home After Divorce
November 5, 2019
Many critical decisions faced during the divorce process require an equal measure of legal, financial, and emotional consideration. For example, the decision to retain the family home typically comes with a strong emotional overlay and can have a huge impact on life following divorce. While many often assume that keeping the home is ideal, especially when young children are involved, it is also important to think through the potential financial risks that retaining the home might pose for you. In order to help make an informed decision, you must ask yourself three questions:
1. What exactly am I accepting when I agree to keep the home?
2. What are the tax implications now and in the future?
3. How will keeping the home impact the long-term sustainability of my assets?
What exactly am I accepting when I agree to keep the home?
If you are the recipient of the home in the community property settlement, it needs to be understood that you are likely trading away other more liquid—and possibly income-producing—assets in exchange for keeping the home, which, in the short term at least, is illiquid and also expense generating. The best way to fully appreciate what this means for you is to handle such a trade-off no differently than if you were buying a new home. It is in both parties’ best interests to have the house professionally appraised and inspected in order to establish its fair market value, and to also understand the estimated cost of the deferred maintenance that you will be inheriting. Moreover, if the home still has a mortgage attached to it, there could be adverse financial ramifications resulting from refinancing to remove one party’s name from the debt and title.
What are the tax implications now and in the future?
As with all assets that appreciate, you will be responsible for taxes applied to the appreciation above its adjusted cost basis, which is generally the original purchase price plus the cost of any capital improvements that were made. Another important factor in determining the future tax liability of the home is the available capital gain exemption of up to $250,000 per individual that each qualifying homeowner receives, which could significantly impact the potential taxable gain if is it later sold by one person rather than two. This is especially important to consider if the plan is to not likely keep the home for the long term. For many homeowners whose properties have appreciated nicely over the years, the potential tax impact resulting from the sale of long-held property can be significant and you could be solely responsible for the full tax bill if sold after the divorce. It is important to not only determine what your future tax liability may be, but also how that cash outflow will impact your long-term financial sustainability.
How will keeping the home impact the long-term sustainability of my assets?
Finally, it is ideal to work with an experienced Wealth Manager early in the divorce process to think through all related financial considerations, especially the need to examine how keeping the family home will impact your overall financial well-being. Thorough cash flow planning should also be done that incorporates these significant issues of illiquidity and non-income producing status, ongoing carrying costs, deferred maintenance, and potential tax liability if gain is realized. Your Wealth Manager should be able to help you better assess things by illustrating different cash flow scenarios based on these inputs plus expected capital market returns and inflation assumptions. Keeping the family home after a divorce is a major decision that has no correct or simple answer; however, understanding the financial impact of that decision will help you better negotiate your settlement agreement and plan for the future.
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