Divorce is complicated under most circumstances, but it is increasingly difficult during a struggling economy. In today’s depressed housing market, many couples are facing the dilemma of how to divide the marital home. Generally, spouses who are divorcing do not want to remain on a mortgage together. With a difficult real estate market, we are seeing more couples who need to bring not only thousands but tens of thousands of dollars to the table to refinance the home in one spouse’s name only. Having $20,000 for a refinance is not always the easiest to do when the divorcees also factor in attorney’s fees, court costs, child support or alimony.
One possible solution is to tap your retirement plans. As financial advisers, we generally do not consider retirement plans as a source for potential cash. But, in the case of divorce, it is a one-time transaction, it is important to have the home situation settled, and if your retirement plan is your only available source, you often have that option. In general, if you withdraw assets from a retirement plan, such as, a 401(k) or IRA, and are under the age of 59½, you will be subject to a 10% early withdrawal penalty, along with paying ordinary income taxes on the distribution. However, in a divorce if it is necessary to split up a 401(k) plan, this is accomplished by a Qualified Domestic Relations Order, or QDRO.
With a QDRO, the receiving spouse may take a distribution from the 401(k) without incurring the 10% early withdrawal penalty. However, the spouse must pay ordinary income taxes. It is important to note that this rule does not apply to IRAs; therefore, if a client orders their awarded benefits to a QDRO, rolls it into an IRA and then takes a distribution, the 10% penalty will apply to the distribution. The spouse must take the distribution prior to a rollover into an IRA to be exempt from the 10% penalty. This cash can then be used to fund the refinance on a marital home.
Alternately, if a spouse alone cannot obtain financing for the property, a divorce decree can require the spouse remaining in the home to sell it at a specified time in the future. Generally, property settlements are non modifiable. However, if the housing market has not turned around, and both spouses agree, terms can be changed.
Selling the Home for a Gain
From a tax standpoint, if you are getting divorced and will sell the home, you may need to plan ahead to take advantage of the tax break. Married couples can potentially exclude up to $500,000 of gain from the sale of the primary home. To be eligible for this gain exclusion, you must have owned the property for at least two years during the five-year period ending on the date of the sale, and you must have used the property as a principal residence for at least two years during that same five-year period.
Selling before a Divorce
If Jack and Diane sell their home in June, but their divorce is not yet final by the end of the year, they could file a joint return for the year. If they meet the basic home sale gain requirements, they can claim the maximum exclusion of $500,000 on their joint return. If Jack and Diane were to file separate returns, each spouse could exclude up to $250,000 of gain. However, Jack and Diane must each meet the property use and ownership tests.
Selling after a Divorce is Final
If Jack and Diane are officially divorced as of the end of the year in which they sold their home, tax law considers them divorced the entire year. If the home were sold soon after the divorce, both Jack and Diane would typically qualify for separate $250,000 exclusions. However if Jack has moved out, and the home is not sold for a long period, Jack may likely fail the two-out-of-five year use test, Therefore, he would become ineligible for the gain exclusion. In this case, Jack and Diane should want to work closely with their attorneys to arrange a condition that would be included in the divorce agreement to avoid an undesirable tax outcome.
Alternately, if Diane were to gain sole ownership of the home, which was formerly owned by Jack, she is allowed to count Jack’s period of ownership to pass the ownership test, when she eventually sells the home. Her maximum gain exclusion would be $250,000 because she is now a single filer.
Equitable Division of Assets
Often when one spouse has filed for a divorce, the other spouse does not agree to the terms of the divorce and property settlement. Quite often one of the main issues that is contested in divorce proceedings include the distribution of the acquired assets. When determining the equitable distribution of marital assets, the courts consider many factors including:
- Length of the marriage;
- Age, physical and emotional health of the spouses;
- Income or property brought to the marriage by each spouse;
- Standard of living established during the marriage;
- Economic situation of each spouse at the time the division of property becomes effective;
- Income and earning potential of each spouse;
- Contribution by each spouse to the education, training or earning power of the other spouse;
- Tax consequences to each spouse, and
- Present value of any marital property, among others.
Conflicting issues increase the time and money needed for the divorce. As the number of issues that are in dispute increase, the more complicated the divorce becomes. At Henssler Financial, we believe you should Live Ready. If you are embarking on a contested divorce, we feel you should work closely with a Certified Divorce Financial Analyst™ and your attorney to ensure your financial needs are met both in the short term and long term. If you would like to speak with a financial adviser about your impending divorce, call us at 770-429-9166 or e-mail experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
