Divorce Tax Opportunities and Risks: The Selling and Transferring of Property
Kimberly Nelson, CFA®, CDFA, provides examples and guidance on the tax tradeoffs of selling and transferring property during or after a divorce.
Kimberly Nelson, CFA®, CDFA, is an Advisor at Coastal Bridge Advisors, one of the many distinguished financial advisory firms on the Harness Wealth platform. She has been working with high net worth divorces in the Los Angeles area for more than 15 years. She understands the common challenges faced when navigating a bevy of attorneys, accountants, insurers and other advisors during the dissolution process, particularly before tax season.
Property, especially homes, can be a particularly contentious part of the division of assets. The financial risks and opportunities here can be steep, so it’s important to make careful decisions around what to do and when while considering all legal and tax-related factors.
For example, even though it may be tempting to hold on to a home until after the divorce process is finalized for personal reasons, it may not be the best decision financially. Kimberly walks through the math behind such a scenario below, and explains how to handle property transfers as well.
The Family Home: Sell Now vs. Sell Later?
Selling your home sooner rather than later can help you take advantage of a combined capital gains tax exemption that can help save hundreds of thousands of dollars.
“I had a client who was hellbent on keeping the home that she and her husband bought when their children were very young – I began working with her about 3 years after her divorce was finalized. Her story is very common and relatable, and hopefully educational as well, for those of you faced with a similar situation,” Kimberly explains.
Post-divorce financial situation for Kimberly’s client:
- $1,000,000 in cash
- A beautiful beach home in a stylish suburb of Los Angeles that was purchased for $4,300,000, with a $2,700,000 mortgage. At the time of the separation, the home was worth about $7,000,000, and the mortgage was paid down to about $2,200,000
- An enormous monthly mortgage bill, with college tuition bills on the horizon for her two sons
After selling the home two years post-divorce:
- Paid $500,000 in commissions and closing costs
- Long term capital gain of about $2,200,000 of which she owed nearly $800,000 in tax.
- This asset that was valued at $4,800,000 on her side of the balance sheet (current value minus the mortgage balance) at the time the divorce was finalized netted her only about 3,700,000. This was after she made five years’ worth of hefty mortgage payments!
So what went wrong here?
As couples are slicing up their estate and moving assets on either side of the newly created “Mine and Yours” balance sheet, they (and often their attorneys) forget about the mechanics of the capital gains exemption of the home.
If you and your spouse sell the home during the divorce, or within 2 years post divorce: You are able to take a $500,000 combined capital gains tax exemption on the sale profits.
If you buy out your spouse at the conclusion of the divorce and then decide to sell it down the road: You will only be able to utilize the single exemption of $250,000. This could mean tens of thousands of extra dollars going to taxes when you are ready to move on, not to mention that you will solely bear the cost of the transaction (closing costs, brokerage commissions, etc.).
Kimberly tells us, “Selling the house now and splitting the profits, along with any associated costs, with your soon-to-be former spouse may be the smartest financial move in the long run.”
In the scenario above, if Kimberly’s client had sold the house with her ex-husband at the time of the divorce, they would have had a combined exemption of $500,000 (as the house was their joint primary residence) and they would have shared in the cost of the selling fees. Her client’s half of the savings would have amounted to nearly $400,000.
Final words from Kimberly: “Are there good reasons for you to stay in your home post-divorce? Maybe. Are there a lot of things you need to take pause and consider before deciding? Absolutely. Definitely discuss these issues with your financial advisor and your attorney as they can help you make the best decision here.”
Property Transfers Between Parties
Conversely, property that will be transferred (for example, a summer home owned by one spouse but being transferred to the other), the timing recommendation could be opposite. When couples are divorcing, property transfers between the two parties generally occur with no tax consequence to either side. It may make sense to forego the tax-free treatment that the law affords divorcing spouses for property transfers.
This is dependent on a variety of factors, such as the value of the property, which state the property is in/the taxes will be filed in, and the respective income brackets of each spouse, so be sure to consult a tax professional about this.
You may want to intentionally create a taxable event by structuring the transaction as a “true sale” more than one year after the divorce is finalized. This could allow the spouse who purchases their ex-spouse’s share to benefit from an increased cost basis on the property.
For potential future property transfer and sales, you may also want to include minimum or maximum values of property in the divorce decree, to hedge against both expected and unexpected changes in property values and the resulting tax bills upon selling.
Take your time with and utilize all of the resources available to you: your lawyer, accountant, financial planner, and a trusted friend or family member who is knowledgeable in these matters and make sure that you are making the best choices at the right times for you and your family.
Advisory services offered through Coastal Bridge Advisors, LLC (CBA). CBA is an SEC registered investment adviser and is not affiliated with Harness Wealth, LLC or Multiplier, Inc.
This article is provided for informational purposes, not as personal investment advice. There is no guarantee views and opinions expressed herein will come to pass.
This article contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.
We are neither your attorneys nor your accountants and no portion of this material should be interpreted by you as legal, accounting or tax advice. We recommend that you seek the advice of a qualified attorney and accountant.
Any hypothetical example is intended for illustrative purposes only and does not represent an actual client or an actual client’s experience. Your experience may vary based on your individual circumstances.