The Danger of Do-It-Yourself Divorce

The Danger of Do-It-Yourself Divorce

Ken & Barbie have been married 20 years and have owned their current home for over 10 years. Without the benefit of legal or tax advice, they decide to divorce with Ken taking his retirement and Barbie taking the equity in the home which are equal in value.

It appears to be equitable until a year later when Barbie decides to sell the home.  It sells for the same market value at the time of the divorce but now Barbie pays all the sales costs.  The unpaid balance on the home was much larger than normal because it had been refinanced for $750,000 two years earlier.

When Ken gave Barbie his equity in the house, he also gave her his tax liability in the home.  Barbie has a substantial capital gain because the home was purchased for a much lower price ten years earlier.  Capital gain is calculated by taking the sales price less sales costs, plus capital improvements made, less the purchase price.

Since she is single, she has a $250,000 exclusion and the balance of the gain of $456,750 will be taxable as long-term capital gains.  Let’s assume her rate is 15%, Barbie would owe $68,513 in capital gains taxes.

When calculating Barbie’s net proceeds from this sale and accounting for the sales costs, mortgage balance, and federal taxes due, she only realizes $88,487 in this example while Ken walked away from the divorce with the full value of his retirement account of $225,000.

It doesn’t appear to have been an equitable settlement.  Contributing to this inequity was an apparent misunderstanding of how taxes are calculated and that the expenses incurred with the sale of the home as a single person would be borne solely by herself.

No gain or loss is recognizable on the transfer of the residence if related to the end of a marriage.  It is treated as a gift with no gift tax due if the transfer is within two years prior to the divorce or one year following.  There is no change in basis; it is carried over to the gifted party.

A marriage is a legal arrangement and divorcing deserves the benefit of expert advice.  An attorney who is familiar with potential tax consequences could have advised his/her client about the potential tax consequences and possibly suggested a more equitable division of assets.

This example is used to show you how it can appear to be an easy solution to dividing the assets.  In an emotional state, one person could agree to something that could be costly later.