The Family Home
Determining how to handle the family home in divorce can be a daunting task. To sell or not to sell? And if the house must be sold, when?
If children are involved, simply selling the home and splitting the proceeds isn't always the best option, though often it's the only realistic alternative in some cases. The family home is a source of stability and comfort during the often tumultuous divorce process for many children. The children's bedrooms may be their sanctuary, and the shock of realizing that their parents are separating combined with the loss of familiar surroundings can be a severe blow.
Keep the following in mind when considering how to handle your home during divorce:
A home means different things to different people, but to many it symbolizes a refuge from the demands of life, a connection to the community, and the anchor of the family unit. Contemplating losing the home due to divorce is never pleasant. Depending on your situation, selling the home may not be necessary. When deciding how to deal with your home during divorce, consider the following four options:
Before you can reach a fair settlement regarding the family home, of course, you must have a firm grasp of the fair market value of the residence. The current fair market value is the amount you would receive if you listed your house for sale on the open market. Obtaining a reasonably accurate figure isn't difficult if you use the appropriate channels. For those of you who live on the internet, know that real estate websites that purport to estimate the value of your home, such as zillow.com, are not nearly accurate enough for this task. That said, your local real estate agent is a valuable resource.
A real estate agent will often prepare an comparative market analysis (CMA) on your property free of charge. This typically involves inspecting your home and then analyzing (1) the inventory of currently unsold homes in your neighborhood, (2) the average length of time a property takes to sell, and (2) data on the sales price of comparable homes.
If you want an even more comprehensive valuation of your home, consider hiring a real estate appraiser. The cost associated with such an appraisal can be quite significant (well over a thousand dollars), but you or your spouse would rather not place your faith in the local real estate agent, a true appraisal is a good bet. Note too that if you and your spouse can't act like grownups and negotiate a fair settlement, divorce mediation will fail, and you will wind up in litigation that involves a battle of appraisers. Start adding together the attorney's fees for both spouses and the costs of separate appraisals, and you will quickly understand why such an approach is financially devastating.
Of course, the fair market value of your home is only the starting point in determining the equity value of your house. The equity value of a home is its fair market value minus all liabilities associated with the home, which may include any of the following: a first, second or third mortgage, a home equity loan, or a line of credit (i.e., debts to lenders), as well as property tax liens, judgment liens, mechanic's liens, and child support liens.
When determining the balance of your mortgage and/or equity loans, always use the "payoff balance" figure. The "principal balance" simply reflects the amount of principal that needs to be paid off. The "payoff balance," on the other hand, includes any prepayment charges required to settle the loan, as well as an additional month's interest.
To get a true picture of the liens on your property, you may need to do a title search. This is simply because tax liens and mechanic's liens may appear that you haven't seen before. To complete a title search, you can either enlist the help of a title company (there are many online) or make the trip to the county recorder's office and ask for the assistance of the clerk in locating your property records.
Capital Gains and Tax Basis
Depending on difference between the price of your home when you bought it and its fair market value today, your home's tax basis may be a critically important ingredient in determining what it is truly worth to you. Many people neglect this bit of information until the time to sell the home arrives, sometimes years after a divorce, and its consequences can be harsh. Remember that in accordance with current tax law, each of your and your spouse have a $250,000 capital gains exemption upon the sale of your primary residence. This total exemption amount of $500,000 is a huge benefit to married couples.
Equally importantly, you can both use your exemption toward the sale of the house if it is sold after divorce and you still own the home together. The IRS rule for qualifying for capital gains exclusion is that you must have occupied your home for 2 of the past 5 years. The IRS generously allows you to "tack on" the occupancy of your home by your former spouse to meet the 2 year rule. Consider the following example:
Jason and Samantha Lee lived in their home for 18 months prior to divorce. According to the terms of their divorce decree, though they still co-own the home, Samantha is entitled continue residing in the home until she sells it, which she does 7 months after divorce. Samantha has lived in the home for over two years, so she is clearly entitled to the $250,000 exclusion from capital gains tax. Jason, however, has only truly lived in the home for 18 months. Nevertheless, because Samantha continued to live in the home for another 7 months following divorce, and the divorce decree authorizes Samantha to continue living in the home until she sells it, Jason is also eligible for the $250,000 exclusion - i.e., Samantha's extra 7 months is tacked onto his occupancy for capital gains tax exclusion purposes.
None of this applies if you buy or "trade" your share of the home from your spouse. In that case, you will only be able to claim your own $250,000 capital gains exemption. Always be sure to analyze the effect the greatly reduced exemption amount will have on your finances. Consider the following example:
Bob and Susie Ohrloff bought a lovely beach cottage in La Jolla, California in 1967 for $39,000. Over the course of the forty plus years between the early years and the date of their divorce, the Ohrloff's little cottage appreciated significantly. In fact, at the time of their divorce, it was valued at $1.2 million dollars. Even with the combined exemption amount of $500,000, the Orloffs would have been socked with a significant tax bill upon the sale of their residence. Indeed, approximately $700,000 of their fain would have been taxed. But Susie is very attached to the home, and she agrees to trade it for its fair market value equivalent in retirement assets. In other words, Susie gets to keep the house by giving up $1.2 million.
Unfortunately, Susie never thinks through the tax consequences of the sale. When Susie decides to sell the home and move to a retirement home five years later, she is socked with an enormous tax bill. Though the house had appreciated only slightly in value since the date of her divorce, thank to her exemption amount of only $250,000, she now owes nearly $175,000 in capital gains taxes. Getting the cottage in exchange for surrendering her right to retirement assets doesn't seem like such a great deal after all.
To calculate the capital gains tax you will pay on your home, you need to understand the tax basis of your home. Put simply, the tax basis of your home is the original purchase price plus acquisition costs and the cost of any improvements you have made, minus certain tax benefit you've realized by owning the home. These values can be located or calculated as follows:
When property is transferred from one spouse to another as part of a divorce settlement, the original tax basis is transferred to the spouse receiving the property. The capital gains tax on the property when it is subsequently sold is calculated using this basis.