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Property, How Will It Be Divided
By: Carol Ann Wilson
Dividing property almost always takes some
finesse. It’s not as simple as taking the total value of marital assets and
just divvying them up. Emotions, perceived value, even not wanting a spouse to
have something because, well - just because - it all plays a part.
Let’s look at an example of how a case can play
out. Marilyn and Tom Baxter have been married for 35 years. She’s a homemaker
caring for their four children and has not worked outside of their home for pay.
Tom earns $150,000 per year and has started a business in the basement of their
home. He expects the new business to create revenues after he retires. Their
home is worth $135,000 and mortgage-free. His pension is valued at $90,000.
Their joint savings is $28,000. Tom estimates his basement business is worth
$75,000. Their combined assets total $328,000. If you assume a 50-50 property
split, each would receive $164,000.
Here are the Baxters’ assets at the time of their divorce:
|
House |
$135,000 |
|
Pension |
90,000 |
|
Savings |
28,000 |
|
Business |
75,000 |
|
Total |
$328,000 |
Splitting the property and assets down the middle is
often not the most equitable division. In this scenario, Marilyn wants the
house. The value of the house will remain in her column on a typical property
settlement worksheet. Tom wants what most men want in the distribution of
assets, the pension. We’ll put the pension in his column.
Tom also has some other thoughts. With the demands of his growing basement
business, he needs cash. He wants the $28,000 savings account. Add the savings
account to his column. Since Tom feels the business in the basement is his, he
wants it all as his property. Put the business in his column.
The division now looks like this:
| |
|
Marilyn |
Tom |
|
House |
$135,000 |
$135,000 |
|
|
Pension |
90,000 |
|
90,000 |
|
Savings |
28,000 |
|
28,000 |
|
Business |
75,000 |
|
75,000 |
|
Total |
$328,000 |
$135,000 |
$193,000 |
Her assets total $135,000 and his assets total
$193,000. If we were to look at a 50-50 property split, he would owe her
$29,000. Although Tom has a large income of $150,000 a year, he does now want to
give up any of the business or pension or savings.
Property Settlement Note
We could even out this division with a property settlement note.
Tom could pay Marilyn $29,000 over time, like a note at the bank. He can make
monthly payments with current market interest. Or, he can borrow funds directly
from the bank, since he has assets, including a savings account comparable to
what he would owe. A property settlement note is an agreement to pay a
specified amount for an agreed-upon length of time with reasonable interest. It
is still considered division of property, so the payer does not deduct it from
taxable income. The payee does not pay taxes on the principal - only on the
interest. It is important to collateralize this note, meaning that the payer
should pledge something of value to guarantee it, in case the payer doesn’t
pay on the note.
If no other asset is available, it is possible to collateralize this note with a
qualified pension by using a qualified domestic relations order (QDRO), a legal
document that directs the administrator of a pension plan as to what amount
(either percentage or dollar amount) is to be given to a non-employee spouse. If
the payer defaults on the payments of a property settlement note, then the payee
can collect pursuant to the terms of the QDRO agreement from the pension. A QDRO
can be used to collateralize a property settlement note.
Suppose Marilyn does not like the settlement
suggested. She believes she is owed the house and wants half of her husband’s
pension because, in their 35 years of marriage, she helped him earn his pension
by caring for their children and managing their household. She also wants half
of the savings, because she doesn’t want to be left without any cash. But she
agrees that the basement business is Tom’s.
Adjust the columns, keeping the house in Marilyn’s column; splitting the
pension, putting $45,000 in each column; dividing the savings, placing $14,000
in both columns; and crediting Tom with the business.
The property split now looks like this:
|
|
|
Marilyn |
Tom |
|
House |
$135,000 |
$135,000 |
|
|
Pension |
90,000 |
45,000 |
45,000 |
|
Savings |
28,000 |
14,000 |
14,000 |
|
Business |
75,000 |
|
75,000 |
|
Total |
$328,000 |
$194,000 |
$134,000 |
Her largest asset is the house, an illiquid asset.
It is paid for, but it does not create revenues to help her buy groceries. She
could rent out rooms for additional income, but that rarely works and it creates
a different lifestyle that she may not want. How is she going to pay this
$30,000 to Tom? The prospects are bleak. Given that Marilyn is in her mid-50s,
has never worked outside the home, and her largest asset is illiquid, this
unequal division may be considered the most equitable.
Awarding alimony comes after the property is divided. The
reason for this is that alimony can be based on the amount of property received,
so it is important to look first at the property division.
Equal versus Equitable
In property division, you trade assets back and forth
until the couple agrees on the division. In an equitable property division
state, you split the property equitably. It does not mean equal - it
means fair.
On the other hand, the word equality suggests
fairness and equity for all parties involved. Unfortunately, the required equal
division of property in most states has forced more sales of family assets,
especially the family home, so that the proceeds can be divided between the two
spouses. The net result is increased dislocation and disruption, especially in
the lives of minor children. This is not fair, in that the needs and interests
of the children are not considered in many cases.
A second problem of equality is that a 50-50 division of
property may not produce equal results - or equal standards of living after the
divorce - if the two spouses are unequally situated at the time of divorce. This
is most evident in the situation of the older homemaker. After a marital life
devoted to homemaking, she it typically without substantial skills and
experience in the workplace. Most likely, she will require a greater share of
the property to cushion the income loss she suffers at divorce. Rarely is she in
an equal economic position at divorce. Our example of Marilyn Baxter fits this
description.
Generally, a 50-50 division is started when property is
divided in an equitable division state. A major consideration can be how much
separate property the client has. Let’s say your spouse has $2 million in
separate property. Your marital estate totals $200,000. A judge who knows your
spouse has $2 million worth of separate property may not give your spouse 50
percent of the marital property. Instead, the judge’s attitude may be, “Well
you have $2 million in separate property, so you get none of the marital
property.”
What’s a Career Worth?
With many couples, one spouse has significant assets tied
to his or her career. These career assets include insurance (life, health,
disability); vacation and sick pay; Social Security and unemployment benefits;
stock options; and pension and retirement plans. Future promotions, job
experience, seniority, professional contacts, and education are also considered
career assets. In many cases, career assets should be considered in arriving at
an equitable settlement.
In 1998, a highly publicized battle over career assets
made the cover of Fortune magazine. Lorna and Gary Wendt were married for
32 years. He was the CEO of GE Capital; she was a “corporate wife.” At the
time of the divorce, he declared the marital estate to be worth $21 million and
offered her $8 million as her share. She balked, saying that the estate was
worth $100 million. Her counter to him was that she wanted $50 million - half.
Lorna Wendt’s position was that her husband’s future
pension benefits and stock options had been earned during their marriage. She
argued that her contribution as the homemaker and later, wife of the CEO,
enabled him to rise through the ranks to the top of an international
organization. Her husband didn’t agree.
In the early years of their marriage, she worked to
support them while he attended Harvard Business School. They moved often while
she handled the details of the household and took care of him and their two
children. When he became CEO, she was expected to entertain often and
extravagantly as his position required. She felt she was a 50-50 partner in the
marriage and the accumulation of all assets.
The Wendt case broke through the long-held belief that “enough
is enough” - that a spouse deserved enough to maintain her lifestyle - nothing
more. In a landmark decision, the judge awarded her $20 million - far less than
the $50 million she had requested, but far more that the $8 million her husband
initially offered.
Putting Husband/Wife through College
Consider the example of a family of simpler means, in
which the husband is the dominant wage earner. It is not unusual for the wife to
put the husband through school or help him become established while abandoning
or postponing her own education. She may have quit her job to move from job to
job with him.
Together, they made the decision to spend the time and
energy to build his career with the expectation that she would share in the
fruits of her investment through her husband’s enhanced earning power. Over
time, he has built up career assets, which are part of what he earns, even
though they may not be paid out directly to him.
Even in two-income families, one spouse’s career often
takes priority over the others. Both spouses expect to share the rewards of that
decision - at least, in the beginning of their marriage.
Some states even place a value on degrees such as the
medical degree, the dental degree, or the law degree. In a 1980 case a couple,
both medical students, agreed that the husband would finish his education first
while the wife supported him. When he finished, she would complete her
education.
After his first year of residency, the couple separated.
The court held that the husband’s medical school degree and license to
practice medicine were obtained during the marriage, and therefore were “property”
and to be considered assets to be divided. It established the value of the
husband’s medical education as the difference in earning capacity between a
man with a four-year college degree and a specialist in internal medicine. With
the help of a financial analyst, the court valued the education at $306,000. The
wife was awarded, in addition to alimony, 20 percent of this amount over a
five-year period.
Myths and Realities in Family Business
Whenever one of the marital assets in a divorce is a
business, there are challenges in dividing this asset. A business can be a
dental, medical, law, or accounting practice; a real estate firm; or a
home-based business. It can be a sole proprietorship, a partnership, or a
corporation.
· Valuing
the business. Any time there
is a small, family, or closely held business, it makes sense to do a little
probing. In fact, you may have to do a lot. We do throw out a caution here. If
you know that the business creates cash flow, it’s definitely worth looking
into. If you know that it’s barely making it, or showing a true financial
loss, strongly consider where you want to spend your investigative monies.
· Dividing
the business. Dividing up a
business is another issue. There are four options when deciding how to go about
doing it:
1. One spouse keeps the business.
2. One buys the other out.
3. Both spouses keep the business.
4. Both spouses sell the business outright and split
the proceeds.
If one spouse is the primary driver in keeping
and running it, it usually surfaces early that the person will continue with it
by buying or giving assets of equal value. If there are no assets large enough
to give, a property settlement note could be created or a loan obtained. If the
spouse owns shares of the company, the company could buy back her shares over
time.
Care needs to be taken when buying out shares of stock. If
there has been an increase in the value of the stock, the selling spouse could
be liable for capital gains tax. If one spouse buys the shares directly from the
other, it would be considered a transfer of property incident to divorce, which
is not a taxable issue.
It is much more difficult to divide a family-owned
business where the husband and wife have worked next to each other every day for
years. They both have emotional ties with the business. In addition, if they try
to divide the business, it may kill the business. Some couples are better
business partners than marriage partners, and are able to continue to work
together in a business after the divorce is final. This doesn’t work for
everyone, but should be considered as an option.
Some couples opt to sell the business and divide the
profits; this way, both are free to look elsewhere for another business or even
to retire. The problem here may be in finding a buyer. Sometimes it takes years
to sell a business. In the meantime, decisions need to be made as to whose
business it is and who runs it.
The scavenger hunt.
Discovering and determining what property should be identified as marital assets
takes a little work. We know that at times, it seems as though you’ve been
sent on a scavenger hunt to find assets. Here’s a list of places to look:
-
Tax Returns
. They show interest and dividend income and name the source. Look at
Schedule B. if you see $5,000 interest from a mutual fund
or bond, you know someplace there is an asset worth about $62,500 (if it is
earning 8 percent). If instead that $5,000 is from a bank or credit union,
it is probably earning more like 4 percent and the asset may be worth about
$125,000.
-
Financial
statements . When used to
secure a loan, these usually have values assigned to assets to pump up the
net worth. If your spouse was trying to impress the bank with your combined
net worth, there may be some assets there worth tracking down.
-
Canceled checks
. A large sum made out to a brokerage firm, mutual fund, or insurance
company would indicate that an investment was made. And that money is
sitting someplace even though you may not have known about it. Make sure
when looking through the checks that you have all of them and there are no
missing numbers.
-
Copies of
investment statements . This
will show values. If you have several months of statements and you see that
the value declined within the past few months due to a withdrawal, find out
where that money went. It may be sitting in a different account someplace
else.
-
Deferred
compensation . Did your spouse
talk about an expected bonus that somehow never got paid? Perhaps the bonus
is still owed but the employer is helping out by holding that bonus until
after the divorce is over. Check it out!
-
Cash business.
Does your spouse own a business that takes in a lot of cash? It is important
to know how much cash flow there really is.
-
Retirement plans
. These are biggies. Remember that in most states, retirement plans are
marital property even if held in only one name. It is important to have the
paperwork on each one.
-
Payroll stubs.
Is your spouse having money withheld that goes into a special account nobody
else knows about?
-
Contracts or
agreements that pay out in the future on work done in the past
. Because the work was done during the marriage, the future payout is
marital property. This category includes royalties, patents, and commission.
Dividing the House
Most assets are in houses and pensions. How one spouse
gets his or her share out of either creates some anxiety, and tension is in the
air. There are three basis options to approaching the issue of who gets the
house. You can sell the house, buy out your spouse’s half, or continue to own
the property jointly after the divorce.
1. Sell the house.
Selling the house and dividing the profits that remain after sales costs and
the mortgage is paid off is the easiest and “cleanest” way of dividing
equity. Concerns that will need to be addressed include: the basis and
possible capital gains, buying another house versus renting, and being able
to qualify for a new loan.
2. Buy out the other spouse.
Buying out the other spouse’s half works if one person wants to remain in
the house or wants to own the house. There are difficulties with this option
that need to be considered.
First of all, you need to agree on a value of
the property (for purposes of the divorce, value is the equity in the house).
Next, decide on the dollar amount of the buyout. Will the dollar amount have
subtracted from it selling costs and capital gains taxes?
Next, a method of payment needs to be selected. If
payments will be made over a specified period, the terms need to be
comfortable for both parties. The payment could be as simple as giving up
another marital asset in trade for the equity in the house. The house could be
refinanced to withdraw cash to pay the other spouse, or a note payable can be
drawn up with terms of payment that are agreeable to both parties. Reasonable
interest should be attached to the note, and it should be collateralized with
a deed of trust on the property. One problem with this arrangement is that it
keeps you in a debtor-creditor relationship with your ex.
There is another problem with buying out your spouse’s
half. Let’s say you get the house and both names are on the deed. The ex can
quit-claim the deed to you so that only your name is on the deed. Now, you can
sell it whenever you want. Although your ex’s name comes off the deed, it
remains on the mortgage. What happens if you don’t pay the mortgage? The
mortgage company will come to your ex for payment. It doesn’t care that you
are divorced. The only way to remove your ex’s name from the mortgage is to
assume the loan in your name, refinance it, or pay it off.
When your ex’s name is kept on the mortgage, it also
may impact credit by making you appear overextended unless there is proof that
you have been making the mortgage payments. This could create, continue, and
even enhance an adversarial relationship between the two of you.
3. Own the house jointly.
The other option-continuing to own the property jointly-is used when you and
your ex want the kids to stay in the house until the children finish school or
reach a certain age, or until the resident ex-spouse remarries or cohabits.
You agree to sell the house after the kids have graduated from school and
split the proceeds evenly. Whoever stays in the house in the meantime can pay
the mortgage payment, while all other costs of maintaining the house plus
taxes and repairs are split evenly. Again, this continues a tie between the
two of you that may create stress.
Here are some examples to help put all these options
into perspective. Mark and Susan had very good jobs when they decided to
divorce in 1986. Susan wanted to stay in the house with the three children and
buy out Mark’s half of the house with a property settlement note. Interest
rates were high. The note was drawn with her agreeing to pay Mark his half of
the equity at 14 percent interest. Then property values began to decline.
Susan’s half of the equity was losing value, while Mark’s was earning 14
percent, even after the interest rates plummeted.
At the time they drew up this agreement, no one presumed
that interest rates or property values would go down. It is always a risk when
you make agreements that extend out into the future. These risks run both
ways.
Lila and Keith had divided all their property, with her
owing him $5,000. She kept the house and was going to sell it in three years
when their daughter was out of high school. The house had $20,000 of equity in
it at the time of divorce. They both agreed that when she sold the house in
three years, she would give him his $5,000. Lila’s attorney knew Susan’s
lawyer and had heard about the case where Susan was paying 14 percent
interest. Lila’s attorney suggested, “Since $5,000 represents 25 percent
of the equity, why don’t you agree on a percentage? That way when you sell
the house you give him 25 percent of the profits. If the house declines in
value and you only get $10,000 profit, you are not paying him half. Or if it
goes up, you both win because you both get more.”
If you are considering dividing assets beyond one year
of your divorce, we suggest you discuss negotiating a percentage versus an
exact dollar amount. If dividing assets prior to a year, specifying hard
dollars usually works better.
When the wife should not get the house.
We have mentioned several times that women are usually attached to the home.
Should a woman always negotiate to keep it? Not necessarily. There are cases
when the wife should not keep the house.
Consider Bob and Cindy. Cindy is 32 years old and Bob is
33. They have been married 12 years. They have two kids, nine and five years
old. Cindy is the custodial parent.
Cindy needs three more years to finish college and get
her degree and another year to earn her teaching credential. She estimates
that she will earn $33,000 a year as a new teacher. Between going to school
and caring for the kids, she will not be able to earn income. Bob is offering
to help Cindy through school by paying maintenance of $2,400 per month for one
year, then $1,500 per month for two additional years.
Cindy’s expenses with the two kids are $3,000 per
month. This includes her expenses for school, which average $350 per month.
Bob earns $75,000 per year and brings home $57,570 per year after taxes. His
expenses are $2,000 per month. Cindy and Bob had trouble staying within their
budget while they were married. Cindy loved to shop and tended to overspend,
maxing their credit cards to their limits.
The family home has a fair market value of $220,000 with
a mortgage of $125,000. Monthly payments are $1,500 per month, including real
estate taxes. Cindy wants to remain in the house with the kids.
It doesn’t make economic sense for Cindy to keep a
house with a $1,500 monthly payment when she has no income of her own and is
relying on maintenance to make that payment for her. She could rent a smaller
house close to where she currently lives for $750 to $800 per month.
Some type of alimony will be received for a few years,
as well as child support for the kids. Selling the house will release cash
that in turn can create income to supplement the alimony and child support she
will receive until she gets her teaching credential.
Maintenance cannot be counted on. What if Bob loses his
job? Both need counseling on cash flow and budgeting. Both must understand
that whatever scenario is followed, it will have a major impact on their
financial, emotional, parenting, and relationship lives.
Tax Considerations
The Taxpayer Relief Act of 1997 has created a big tax boon
to the majority of taxpayers, and is a disaster to others when it comes to
capital gains. It has also created some complications. The details of the new
tax law are anything but simple. Let’s take a look.
The previous law taxed net capital gains at 28 percent.
This was great for those in the 31 percent, 36 percent, and 39.6 percent tax
brackets. But it gave no benefit to those who were taxed at 28 percent or lower.
The maximum tax rate on net capital gain is generally
lowered to 20 percent for all taxpayers (except those in the 15 percent tax
bracket, for whom it is now 10 percent).
For years, taxes on capital gains from the sale of the
home were subject to deferral or a one-time exclusion. First, homeowners have
been able to defer the capital gain by buying another home within two years
before or after the sale of their home. Second, homeowners age 55 or older had
the one-time opportunity to exclude $125,000 from their capital gain when
figuring their taxes.
The new tax law eliminates these two options for sales
made after May 6, 1997, and replaces them with a new exclusion that should help
most - but by no means all - homeowners. The new tax law provides an exclusion
of up to $250,000 for single people and $500,000 for married couples. This is a
big plus.
What do the terms capital gains and basis
mean? Basis is the original investment in your first home increased by selling
costs and any improvements. Another common term used is adjusted basis.
Capital gains are the amount of profit you made when comparing the adjusted
basis with the selling price of your last home.
The rollover is no longer available. And the home must
have been used as the principal residence by the seller for at least two out of
the five years before the sale. The new tax law also provides fulfillment of the
residency requirement by the nonresident spouse. In other words, if you get the
house in the divorce, sell it four years later, and split the profits with your
ex, you both get to take a $250,000 exclusion because one of you fulfilled the
residency requirement.
Let’s look at some examples:
John and Mary are getting divorced. John is awarded the
jointly owned family home for four years. At the end of the four years, John
sells the home and 50 percent of the proceeds are sent to Mary.
Scenario A: John sells the house for $400,000. Mary will
receive $200,000 and will be entitled to use her $250,000 exclusion, even though
she has not lived in the house for the previous four years.
Scenario B: John sells the house for $750,000. Mary will
receive $375,000. If the basis in the property was $100,000, Mary’s portion of
the basis is $50,000, leaving her with a $325,000 gain. Even though she uses her
$250,000 exclusion, she will be taxed on $75,000 of gain.
|
Sales Price |
$750,000 |
Sales Price |
$750,000 |
|
Basis |
-100,000 |
John’s Half |
375,000 |
|
Capital Gain |
$650,000 |
Mary’s Half |
375,000 |
|
|
|
|
|
|
Mary’s Half of Sales Price |
$375,000 |
|
|
|
Mary’s Half of Basis |
-50,000 |
|
|
|
Mary’s Half of Capital Gain |
$325,000 |
|
|
|
|
|
|
|
|
Mary’s Exclusion |
-250,000 |
|
|
|
Amount on Which Mary Will Be Taxed |
$75,000 |
|
|
The 1997 tax law would be disastrous in some situations.
Here’s how: Vicki and Stan are getting divorced and Vicki is taking the house,
worth $750,000. The basis in the house is $200,000. Vicki decides to move to
another city and buy another house for $750,000. She wants to maintain her
current life style and, as often happens, does not check into tax law or get
financial advice before making a decision that may haunt her at a later date.
Her gain on the sale is $550,000. She will be able to use
her $250,000 exclusion but will still have to pay taxes on the gain of $300,000,
even though she bought another house of equal value! Remember, the capability of
rolling over personal residential gains is a thing of the past
|
Sales Price |
$750,000 |
|
Basis |
-200,000 |
|
Capital Gain |
$550,000 |
|
|
|
|
Exclusion |
-250,000 |
|
Amount on Which Vicki Will Be Taxed |
$300,000 |
One good thing that the new tax law created was a
recurring exclusion. You can use it over again every two years. If you buy a
house and sell it after two year, you can use the exclusion again.
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