To Stay or Not to Stay — That is the Question
By FPA Member Lili A. Vasileff, CFP®, CDFA™
Last Updated: August 1, 2011
The home is typically the largest marital asset. The decision to stay or not to stay in it is not just a financial one, but often a highly emotional one. You may have difficulty putting this decision into perspective, and making a sound, beneficial decision will require you to understand all the issues you face surrounding this asset. The starting point for this analysis is an accurate income and expense statement and cash flow projection. Related divorce topics, such as division of marital assets, should be discussed also in conjunction with this analysis.
Your financial decision is three pronged: 1) sell the house, 2) keep the house, or 3) keep the house and agree to a future sale (and equity distribution). Sometimes, neither you nor your ex-spouse have the financial capability to keep the house due to limited assets and income. Selling the house is a clear-cut strategy for dividing marital assets equitably and managing cash flow.
If you have adequate non-home assets, dividing the marital assets may be easier because the value of the equity in the house can be offset by other assets for your spouse. This reallocation of an equitable division of marital assets enables one party to keep the house.
Now the question becomes, can you afford to live in the house with its upkeep in the near term as well as in the future? A rule of thumb used by creditors/mortgagors is that the ratio of housing expenses to total income should be 30-36 percent. You must have sufficient support and income sources to cover total housing related expenses. It may be helpful to identify what circumstances would prevent you from being able to afford the house and how likely these events are to occur.
If you can afford the house, next ask yourself, does it make financial sense to keep it? What are alternative housing costs: house, condo, rent vs. buy? Typically, it makes more economic sense to buy rather than rent because of tax deductible expenses and future appreciation of the asset. However, based on historic data, real estate does not appreciate as rapidly as liquid securities. Clearly in recent times, housing declines have been precipitous. So, is the house a desirable asset and will it be in the future? Are you ready to assume the full burden of home ownership and maintenance? How much of an economic benefit or drain will this house be?
There are other specific reasons to keep the house. For example, divorcing couples with children often hope to maintain some degree of stability in their children’s lives. They often view the home as a center of stability. Therefore, spouses may agree to postpone the sale of a house for a defined term. At the end of this term, both parties agree to a distribution of their share of the equity in the house.
If you choose this strategy, it is important to set the value of the home equity in the divorce decree so you have closure on this item. Valuing equity is not necessarily easy. You can fix the equity value today based on its current fair market value (FMV). At the expiry of the term, this equity value is to be allocated between the parties.
Alternatively at the expiry of the term, the equity may be fixed as a percentage of the future FMV to be allocated later between the parties. Thus, the party occupying the house has to provide the agreed upon share of the equity to the spouse, either by selling the house or by raising the amount from other resources. This ultimate payoff should be addressed in the divorce decree as either a lump sum amount or as installment payments.
Be cautious when keeping the house. Certain legal documents will need to be updated, such as the mortgage loan, title, property tax records, and homeowner’s insurance. It is important for you and your spouse to be knowledgeable about the costs of updating necessary legal arrangements. For example, what are the costs associated with refinancing a mortgage, or reapplying for insurance? Should these costs be shared? Ex-spouses may agree to share expenses relating to necessary house repairs and maintenance (and even moving expenses) during the period of the term. What happens if the home fails to sell when expected? Do costs continue to be shared or does one spouse get “stuck” because the divorce decree included a specified period?
Upon the sale of the home, you and your ex-spouse need to agree upon a selling price, broker, showings, etc. It is useful to discuss the practical issues relating to the actual sale of a house during the divorce process to flush out prospective areas of discomfort and disagreement. Too many ex-spouses fail to plan the logistics for selecting a realtor, showing, prepping/staging, or negotiating the sale.
Lastly, the tax implications relating to the sale of the marital home are important to know. Taxpayers are allowed to exclude up to $250,000 ($500,000 for married, filing a joint tax return) of capital gain on the sale of a principal residence. To be eligible for the exclusion, the taxpayer must have owned the residence and occupied it as a principal residence for at least two out of five years prior to the sale. However, if a spouse is granted the use of the former marital home under a divorce or separation instrument, the non-occupying former spouse does not need to satisfy the occupancy agreement for exclusion. This exclusion is allowed each time a principal residence is sold, but generally not more than once every two years. Gain will be recognized to the extent that depreciation has been taken for rental or business use of the principal residence at a federal tax rate of 25 percent, plus applicable state income tax. If a gain exceeds $250,000, tax must be paid. No rollover of gain is allowed as under prior law.
In conclusion, a divorce financial planner can provide you with calculations to help you decide to keep or sell the house. It may take time, however, for you to grapple with the emotional piece of this decision. A house means a lot of different things to different people. It can serve as a reminder of the failed marriage, a souvenir of the relationship, a refuge for the children, or a solid financial investment.
FPA member Lili A. Vasileff, CFP®, CDFA™, is the President of the Association of Divorce Financial Planners, the largest national not for profit organization of divorce financial planners and allied divorce professionals, and President of her own private practice called Divorce and Money Matters, LLC.