Your primary residence in a divorce
October 10, 2009
photo credit: steakpinball
Joe,
My wife of seven years and I have been talking about divorce. While nothing is finalized yet, I am curious what we can do with our family home. Should we sell it now and split? Wait? Will the selling hurt us coming tax time?
Roland, White Bear Lake
Roland,
First, let me say I am sorry to hear you are going through such a difficult time. Divorce is not easy—not emotionally and not financially. While I hope you don’t need this advice, it is good you are preparing now.
I am not sure of the exact particulars of the situation—for instance having kids, time lived in home, and current marital status all play a role in determining the best course of action. That said, here is a hypothetical example I give many of my clients:
Let’s say Jack and Jill, a couple who has been married for five years, decide to separate. In the past, in a housing market long, long ago, it would have been easy for the couple to sell the home and divide the profit. If they divorced and filed as “single”, Under IRC §121 Jack and Jill could exclude up to $250,000 of gain on the sale of a principal residence if the ownership and use tests are met. To meet these tests, both Jack and Jill would need to 1) own and 2) use the home as their primary residence for two of the five years preceding the sale. However, if one of the spouses did not meet the test, they might be best off staying married until year end and file jointly. This way Jack and Jill could claim $500,000 so long as they both meet the use test and one of the two meets the ownership test.
Additionally, reduced exclusions are available to those couples who fail the two out of five year test due to health, employment, or marital changes—think divorce or lay off.
However, the plummeting real estate market has turned many homes into toxic assets. Many couples cannot afford to sell their homes at their current value. In that situation, Jack and Jill may decide to have Jill continue to live in the house, and pay Jack his portion when she sells or refinances the house. However, this is problematic in a couple respects.
First, with the current real estate market, it may be a considerable time before the home is sold at a favorable price, leaving Jack waiting for his potential payout. Second, Jill would need to sell the house within three years of the divorce for Jack to be eligible for the exclusion. This time frame can be extended to six years if the former spouse is granted use of the home by a divorce “instrument.”
Also, Roland, make sure you keep the lines of communication open with your former spouse. This will provide a chance to communicate a strategy that is most advantageous to both of you. Then make sure you find a tax professional to handle the situation should the divorce proceeding continue. Not only will they provide you the best strategy to minimize your taxes, they will also protect you so you don’t unwillingly underpay your taxes and be liable for penalties years from now. The rules governing divorce and deductions are complex and nuianced. Also, it may sound ideal to use the family CPA—they have done the family taxes for years afterall. However, in divorce proceedings it is best for each party to have his and her own accountants, as some of the decisions that could be advantageous to one client, might be disadvantageous to the other. You want to make sure your CPA goes to bat for you.
Hope this information helps. As always, contact me should you need further advice. Best of luck reaching an amicable solution.
Estate Taxes
September 28, 2009
Hello, Joe,
What are you hearing about the estate taxes for 2010?
Barb, Edina, MN
Hello, Barb;
There’s a fair amount of speculation about what will happen with the estate taxes. The current federal estate tax law allows a $3.5 million dollar exclusion. However, the estate tax is due to be completely eliminated in 2010 (This is a sunset provision written years ago into law). However, a number of sources view such an event as unlikely to happen.
There are two reasons that this is unlikely. First, the current federal budget deficit will require tax revenues to be at least be at the 2009 level for the foreseeable future. Secondly, if the estate tax expires, the step up of basis in assets passing through an estate would expire as well. Beneficiaries have limited knowledge about the cost basis of assets that are held by decedents. The potential complexity of unknown or incomplete cost records would cause both the beneficiaries and the IRS overwhelming problems.
The most likely legislation will be simply an extension of the existing estate tax laws and exemption, for another year. This will allow a busy Congress to visit the issue next year. The majority of clients still believe that “I’m going to get taxed some how, some way, and I’m not going to like it”,
Estate planning is still important.
Joe
photo credit: simonsimages
Financial Planner Questions
September 28, 2009
Annie, Twin Cities area
Annie:
Listed below are eight key questions you should ask a Financial Planner:
- 1. Do you serve clients in a fiduciary capacity? Ask the advisor to put in writing whether they uphold the fiduciary standard. Also ask if they have a client bill of rights.
- How are you compensated? There’s a difference between “fee-only” and “fee-based”. Fee-only means an advisor if paid a flat fee, a percent of the value of a client’s assets or an hourly fee. (No commission). Fee-based means an advisor takes either fees or commissions on products or services they sell.
- Can you provide professional references? The SEC forbids advisors from disclosing any client references. Therefore ask for a CPA or attorney reference.
- Do you have any disciplinary action against you?
- Do you have an independent custodian for client assets? It’s important to have an independent custodian hold your assets. In the Madoff situation, the Madoff firm held the assets.
- What is your ratio of clients to investment advisors? 50:1 is an average amount.
- How is your portfolio invested?
- What is the total cost of services? Ask for an annual estimate of the costs. The cost should include visible and the invisible costs.
By asking a financial planner these questions, you gain some valuable insight.
Joe
