Money matters are often at the heart of divorce disputes.
If you happen to be in the midst of splitting from your spouse or are considering it, be aware that aside from the price tag of divorce there are other parts of the process that can unexpectedly end up costing you money.
You should have an attorney and a financial advisor advocating for you. Regardless, you need to understand the implications of all money-related decisions.
Do your homework and find the right attorney and financial team to walk you through the technical legal and financial aspects.
Not all assets are equal
Some assets appear to have equal values. Yet once you factor in taxes, they may not look so identical. A dollar in cash money is different in value from a dollar in stock. Selling stock likely has tax implications. The profit made on any given assets which is the difference between what you paid and what you sold it for will be taxed as either a long-term or short-term capital gain once sold, depending on whether the asset was held for under or over a year.
Some assets can have the same value now, but the cost basis for them may be different, and one will have more or less taxes than the other. For dividing assets, you need to subtract the taxes from the value.
If you retain a 401k, you should know that any money withdrawals are taxed at ordinary income tax rates.
Retirement accounts
If you have a 401(k) or other retirement account, be careful how you arrange the split.
Try not to withdraw funds from a 401(k) and then give it to the spouse because of tax withholdings and if the account holder is younger than age 59½, a 10% penalty for early withdrawal could apply.
Instead, you need an attorney to draft what’s called a qualified domestic relations order, or QDRO. This is separate from the divorce agreement, although it is based on the contents of that decree. It, too, gets approved by the court and sent to your 401(k) plan administrator (which also must okay it). A separate order is required for each retirement account being divided.
There are a couple ways your ex-spouse can get their share of the 401(k), both of which must be spelled out in the QDRO. The first is via a trustee-to-trustee transfer to a rollover IRA, which is not a taxable event for either of you.
Some ex-spouses choose to have the QDRO specify that they should receive 401(k) funds directly from the plan. If this route is chosen, the recipient would pay no 10% early-withdrawal penalty, but ordinary income taxes would be due on any amount that does not get contributed to a rollover IRA within 60 days.
Although splitting an IRA does not require a QDRO, you still must do a trustee-to-trustee transfer, with the funds put in a rollover account for the recipient.
Make sure that if the intent is for each spouse to get, say, 50% of a retirement account’s assets, the divorce decree (and QDRO) state that percentage instead of a dollar amount.
The family house
Oftentimes, divorcing couples sell the family home and divide the proceeds as dictated.
Other times, one of the spouses remains in the house. Here, are a few things to watch for:
Assuming your ex will no longer be a joint owner or responsible for any mortgage on the home, you would need to refinance the loan and qualify for it on your own.
Be sure to get an appraisal as well as determine the cost basis of the property. Once it is in your name only, and you go to sell it at some point, you alone will be responsible for paying capital gains taxes on any profit that exceeds the exclusion for a single person.
There are some other tricky situations that could result in a bigger capital gain than anticipated.
If you and your spouse bought your current house before 1997, there’s a chance deferred gains from another home sale were rolled into the purchase.
If so, the cost basis of the property being evaluated in divorce needs to be reduced by the deferred amount. That generally will result in a bigger profit when sold.
If the departing spouse used a home office, which resulted in the home’s depreciation over that time (for tax purposes), the cost basis must be lowered to reflect that amount. Again, that generally would result in a larger gain upon the property’s sale.
Bottom Line
You cannot likely maneuver through the legal process without an attorney. You cannot expect to navigate the tricky tax laws and financial issues without a financial advisor. Be sure your attorney is willing to put you in touch with the proper team.
Ronald Lieberman, Esq. is a shareholder and partner at ALBFRM, PA. Focusing his practice on all areas of divorce and family law, Ron represents clients throughout New Jersey facing the prospect of divorce and other related family law matters.
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