Divorce: Do You Really Want to Keep the House?
Having trouble in your divorce deciding whether or not you want to sell your house or buy out your spouse’s share of the equity and keep it? In many cases, the financial pressures of divorce make selling the house a no-brainer—you may simply need the funds as soon as possible.
When the decision is less clear cut, however, weighing the pros and cons can be confusing. Here are a few tips to keep in mind if you find yourself in this situation:
Try not to let emotions control your decision: A family home can have a powerful allure. While some people are more than happy to look for a new place to live and a fresh start in the wake of a marital breakdown, others remember only the happy moments in the home and see it as a place of security and comfort. If children are attached to a home, their feelings can create an additional psychological barrier to the idea of moving. The bottom line though, is that you could be setting yourself up for long term financial stress if you let the prospect of a temporary adjustment blind you to economic realities. Making a choice based on good sound logic is bound to serve you best in the long run.
Consider all of the economic aspects, not just the value of the home equity: Evaluating keeping a home versus selling a home requires taking into account both the ongoing costs of remaining in the home and the relative value of keeping the home as compared to keeping other assets, such as retirement accounts, investments, or simply the cash that you would receive from the sale. We blogged not too long ago about pitfalls to watch out for when you need to sell your marital home during the divorce process.
Ongoing home expenses come in many disguises and often include unexpected items: Consider all the following in projecting a budget for your home expenses:
- Are you able to take over the current mortgage payments or refinance the home without undue strain?
- How much do you currently spend on things like home repairs, lawn care, or snow removal, and are you able to either continue paying for all of these things or perform some of the tasks yourself?
- How old are key components of the home such as appliances, roofing, and carpeting, and what is their replacement cost?
- How much are your property taxes likely to increase over time and can you budget for the increase?
Valuing the home accurately can be even more complex: Getting an accurate assessment of resale value is just the first step. You may also need to consider some or all of the following:
- Are home prices rising or falling, and what is the impact of this based on how long you may be planning to keep the home?
- If you will be trading retirement assets or pension rights for the home, do you have an accurate future valuation for those items from a financial professional?
- Will you be able to keep working long enough to recoup any lost assets that you will need to support yourself later?
- Would paying real estate commissions and capital gains tax on your own later be significantly more expensive than paying such amounts jointly with your spouse now?
It helps to have a basic understanding of how capital gains tax applies to the sale of a principal residence: When divorcing spouses transfer property between themselves, the tax effects are deferred and the spouse who buys the asset from the other spouse keeps the original basis in the property and becomes responsible for payment of all capital gains taxes on a later sale. The following is a simplified example of how this works:
Suppose that you and your spouse originally bought your home for $100,000 and when you purchased your spouse’s share of the equity, the home value was $400,000. If you sell the home on your own for $550,000 a few years later, your taxable profit would be the sales price minus the original basis, or $450,000. A married couple would be able to exclude up to $500,000 of profit on the sale and would therefore pay no tax. As a now single individual, however, you would only be able to exclude $250,000, and would have to pay capital gains tax on the remaining $200,000 of profit.
How significant is this? Well, it depends on how high your overall income is and whether you have any other capital gains besides the profit on the home sale. Rates in the highest brackets for both ordinary income and capital gains went up in 2013 with the passage of the American Taxpayers Relief Act. Capital gains tax rates are now between 0 and 23.8%, depending on all the applicable factors. Unless you are a financial professional, this is not something you should try to calculate on your own. Even CPA’s are finding it a challenge to work out all the twists and turns of the new tax rules.
Comparing the value of different types of assets and investments is not a simple undertaking. Consult a financial advisor to assess the potential impact of keeping or selling any assets that you own either individually or jointly with your soon-to-be ex-spouse. Keep in mind that impending changes in tax laws can make these contingencies difficult to evaluate.
Once you have carefully completed all of your financial homework, what can you do with the information? First of all, if you can’t afford the house, don’t keep it. Straining to make payments now will just mean that you have less available to put into a new place if you have to sell in a few years. On the other hand, if you think you can afford the house and want to keep it, use the information about all the expenses you will face to negotiate the best possible buy-out price from your spouse.