One thing is usually certain in the aftermath of a divorce: You’ll experience a reduction in net worth and in standard of living. This is unavoidable as one household becomes two.
But just because it will happen doesn’t mean you can’t take steps to lessen the blow. By choosing wisely and unemotionally when dividing the marital assets with your spouse, you can minimize the reduction in your net worth post-divorce.
Not all Dollars Should be Valued Equally in Divorce
Although all asset transfers between spouses (incident to divorce) are tax-free events, some of those assets may later be subject to sizeable income and/or capital gains taxes that must be paid entirely by the receiving spouse, significantly diminishing their net value. It is imperative that these consequences be known and understood by you and your attorney so that you don’t end up with less than your fair share of the net assets.
Which Assets and/or Dollars are Most Valuable?
Value means many different things to many different people. When dividing assets between spouses, it is important to keep in mind the classes of assets identified below, which vary in net present value. If you and your spouse are trading assets from different classes, adjustments may need to be made to ensure you are not losing fair value.
- Cash is king! It is both liquid and not subject to any further taxes. It doesn’t get any better than that!
- Cash, funds in checking and savings accounts, and the money market portion of any investment accounts.
- Home sale proceeds. If the family home is sold as part of the divorce, those proceeds are also liquid and not subject to further tax (as any capital gains due will be paid at the time of sale, after application of your combined spousal $500,000 capital gains exclusion).
2. Other assets not subject to any further tax. Generally speaking, the replacement cost for these items exceed their private re-sale value. Retaining those items as part of your divorce will mean less dollars spent by you post-divorce to get yourself situated.
- Furniture and home furnishings.
- Automobiles.
3. Assets subject to capital gain but not income taxes. These assets will fluctuate in value and will be subject to capital gain taxes if you need to sell them to generate cash. The order of priority in each case will vary depending upon the tax basis of each asset or holding:
- Stock and/or mutual fund holdings in investment accounts. These may also throw off interest and/or dividends, which, in some cases, is taxable income to you.
- The family home. Depending upon the home’s tax basis, you may face a hefty capital gains bill if you assume ownership and then sell it later. Further, at the time of that sale, you’ll only be able to use your own $250,000 capital gains exclusion, as opposed to the combined $500,000 exclusion for spouses.
- Other real property not used as primary residence. Any capital gains problem is compounded with these properties because there is no applicable capital gains exclusion.
- Stock options
- Vested restricted stock
- Some artwork
4. Assets subject to income tax at the time of exercise or withdrawal. These assets will also fluctuate in value. However, when it comes time to withdraw from them, you’ll be taxed on those withdrawals and/or distributions at your ordinary income tax rate in the year in which you take the distributions. Accordingly, the present value of retirement assets, when compared to cash assets, must be adjusted for both present value (as cash is available to you now, whereas retirement, if drawn early, is subject to an additional 10% penalty tax) and after-tax value.
- Most employer sponsored retirement plans (note: IMF and World Bank pensions are not taxable)
- IRAs
- Certain pension plans
- Retirement annuities
Each divorce is different and there can be legitimate reasons why assets are divided a certain way. The information above is intended to inform and educate you, so you can use that knowledge to move forward in a strategic fashion.