Chapter 13 What Will Happen to the House?

• Library: Divorce & Money (Nolo) (2020 Ed.)

CHAPTER 13: What Will Happen to the House?

Financial vs. Legal Realities

The House—Keep It, Transfer It, or Sell It? Now or Later?

Steps Toward Settling the House

Step 1: What Is Your Total Housing Cost Per Month?

Step 2: What Is the Current Fair Market Value of Your House?

Step 3: What Is the Equity Value of Your House?

Step 4: How Much Will It Cost to Sell the House?

Step 5: What Is the Tax Basis for Your House?

Step 6: What Will the Financial Value of Your House Be If You Sell It With Your Spouse?

Step 7: What Will the Financial Value of Your House Be If You Sell It in the Future?

Step 8: What Is Your Share of the House?

Step 9: What's Your Best Option Regarding the House?

Step 10: How to Purchase the House From a Spouse or Former Spouse

Questions to Ask an Attorney or Financial Adviser

If you're a homeowner, a divorce raises some difficult questions. Before making a decision, think through all the available options.

SKIP AHEAD

If you and your spouse don't own a house, skip ahead to Chapter 14.

Ahome can represent the partnership between husband and wife, a place where the children grew up, and a refuge from the demands of life. Perhaps your house stands for a connection to the community—or to the future generations of your family to whom you had hoped to bequeath it.

Whatever your house has meant to you, you're threatened with its loss during divorce. But rather than thinking you will "lose" your house, consider at least four basic options available to you:

Option A: Buy out your spouse's share and either keep it or sell it in the future.
Option B: Sell your share of the house to your spouse.
Option C: Sell the house together and split the proceeds with your spouse.
Option D: Continue to own the house jointly with your spouse and either buy your spouse's interest or sell yours in the future to your spouse or a third person.

To ease your anxieties, it helps to look at the numbers to find the true value of your home so you can make an informed choice. In the following sections, we explain the financial factors you need to consider before choosing the best option. Make sure that any appraisal of the value of your home is a current one, not an estimate from months or years earlier.

CAUTION

The laws in your state and the circumstances of your particular case may affect your options regarding the house. For example, if you cannot reach an agreement concerning the house, judges may presume that a custodial parent will stay in the family home until the children reach maturity. In that case, you would not be able to sell the house and split the proceeds with your spouse (Option C). Rather, the custodial parent would have to buy out the other parent's interest, or you might sell the house some time in the future (Option A or D). If you are unsure of your state's laws regarding custody and the right to sell the house, consult with an attorney before completing the calculations in this chapter.

Financial vs. Legal Realities

To understand your options better, consider home ownership from both legal and financial perspectives.

Suppose that during your marriage, you and your spouse bought a house using income earned from the marriage. You might assume that if you sell the house, the proceeds will be split 50-50. But the following table compares the legal and financial realities.

Legal Reality

Financial Reality

In the 41 states that follow the principles of equitable distribution, it's quite possible that the proceeds of the house won't be split down the middle. The 41 equitable distribution states are all the states except Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In Alaska, couples can opt in to a community property system. And in South Dakota and Tennessee, a married couple can elect to designate property as community property when it is within a trust. See Chapter 12 for a full discussion.) In equitable distribution states, judges are supposed to divide property "fairly." "Fair" doesn't necessarily mean "equal." In reality, "fair" could mean that one spouse receives a greater share of the proceeds.

If you and your spouse can reach your own settlement without going to court, you can each negotiate the best deal for yourself, rather than have a judge impose one on you. Rarely is anyone happy with the settlement a judge carves out. The judge won't factor in most financial consequences of keeping or giving up certain assets. A negotiated settlement, though not always perfect, is usually more palatable.

The House—Keep It, Transfer It, or Sell It? Now or Later?

If you've been in a house any length of time, you're probably accustomed to paying a set amount each month on your mortgage. Many people going through divorce simply focus on that monthly payment, which often looks lower than anything they would have to pay if they moved into an apartment or bought another home.

But looks are deceiving. A low or moderate monthly payment can keep you from seeing many of the other costs of owning a home. Suppose you do keep the house. First of all, a refinancing process may mean that your monthly payment increases, especially if you take cash out to buy out your spouse's share. In addition, will you be able to cover the cost of insurance, property taxes, repairs, cleaning, painting, and the like? What if you decide to sell the house in a few years? Are you prepared to cover the costs of the sale? Can you afford to buy out your partner's share of the house and still have money to live on? Unless you know the true financial costs of keeping a home, you can't answer these questions.

Steps Toward Settling the House

Here's a bit more about the most common scenarios for dealing with the family home at divorce.

Option A: Buy out your spouse's share and either keep it or sell it in the future.

This option can hold the most unforeseen financial risks. Therefore, you'll want to take into consideration as many known factors as possible. You must determine whether you can afford your monthly housing costs. You also want to estimate how much you can expect to make if you sell the house, and recognize the tax implications of a future sale. And, you want to compare what you would receive if you and your spouse sold the house now. Of course, if you plan to keep the house for life, you don't need to worry about future sales costs or income taxes.

A Tax Break on Capital Gains

Before May 6, 1997, the rules for determining the financial value of the family home often made it an asset of questionable value in a divorce settlement, because any profit realized from its sale could ultimately be eaten up in taxes. With changes to the tax code since that time, however, many homes are now sold without incurring capital gains taxes. The key change, for purposes of this discussion, is that capital gains—such as profit from selling the house—are not taxable up to $250,000.

Most capital gains that exceed $250,000 are taxed at a maximum capital gain tax rate of 15%. But for some homeowners, gains between $250,000 and $500,000 are also tax free. To qualify for the $250,000 exclusion, you must have owned and occupied the residence for two of the five years prior to the sale or exchange of the house. (Even if you sell sooner than in two years, you may be able to reduce or eliminate capital gains taxes on your profits under certain circumstances. Those exceptions would include being forced to sell the house for health reasons, a change in your place of employment, or because of an "unforeseen circumstance." The IRS defines the latter as war, man-made or natural disasters, losing your job, death of a spouse, and divorce or legal separation.)

If you are still married (or are remarried) when you sell the house, you and your spouse will owe no taxes on the first $500,000 of gain if you file a joint tax return and all of the following are true:

• either spouse owned the house two of the last five years
• both spouses used the house two of the last five years, and
• neither spouse used the exclusion during the prior two years.

If you hold on to your house and sell it after remarrying, you may have to pay taxes on gains over $250,000 if, for example, your new spouse doesn't live in the house at least two years, or if your new spouse used the exclusion on the sale of a different house during the previous two years.

Option B: Sell your share of the house to your spouse.

To determine whether or not your spouse is making a good offer for your share of the house, you must understand its true financial value. The steps below will help you figure that out.

Option C: Sell the house together and split the proceeds with your spouse.

Before choosing this option, you need to know not only your current housing costs and equity value—you also need to know the costs of selling the house and the amount of profit you will realize after the taxes are paid.

Option D: Continue to own the house jointly with your spouse and either buy it in the future from your spouse or sell it in the future to your spouse or a third person.

When a divorcing couple holds on to their house, it's usually either because a custodial parent is staying with the children or because the housing market is so weak that the couple doesn't want to sell the house yet. However, owning the house together can be emotionally and legally tricky. If you do it, make sure you have a written agreement ensuring that the out-of-house spouse's $250,000 capital gains exclusion is preserved. This agreement must be pursuant to a "divorce or separation instrument"—meaning a divorce judgment or related document that discusses your arrangement about the home; a written separation agreement; or a decree requiring one spouse to make payments for the support or maintenance of the other.

If the agreement doesn't meet the strict requirements of the Internal Revenue Code, the out-of-house spouse could lose the exclusion. (See "A Tax Break on Capital Gains," above, for a general...