Tips for Ensuring an Equal Split
One of the most common mistakes made by couples splitting up assets in a divorce is taking a “snapshot” of all assets’ current market value and using that amount to make decisions. This approach does not take into account the tax liabilities and potential long-term value of assets and can lead to an inequitable division.
In addition to current value, it’s important to consider the following when assessing the true value of assets.
$100 equals $100 equals $100, right? Not necessarily if $100 is held in cash, $100 is invested in stock and $100 is held in an employer-sponsored retirement plan, because each of these asset types have different tax liabilities. It’s important to consider the tax implications of various assets when dividing assets in a divorce. Consider the following examples.
- Cash vs. stocks – $100 in a savings account has no tax liability. However, when a stock worth $100 is sold, the difference between its cost basis and current value is taxable as either long-term or short-term capital gains. Therefore, due to difference in tax treatment, $100 in cash and $100 in stock are not equal.
- Cash vs. retirement account assets – Similarly, withdrawals from employer-sponsored and tax-deferred accounts, such as a 401(k)s and IRAs, are taxed as ordinary income upon withdrawal, which can significantly reduce the actual amount of money received.
- Cash vs. real estate – Following a divorce, it’s common for one spouse to assume full ownership of the home. If you’re the spouse who stays in the home, you’ll need to refinance the mortgage (if there is one) and transfer the home into your name. Once you have sole ownership, you’re responsible for paying capital gains taxes on any profit that exceeds the current exclusion of $250,000 when the home is eventually sold.
This $250,000 exclusion is an important consideration, because if you decide to sell the home prior to your divorce and split the proceeds, you’re subject to a higher exclusion amount of $500,000. That can make a big difference come tax time.
Potential investment returns
On the flipside of the taxation issue, not all assets have the same growth potential, which is why it’s important to consider the future value of assets. For example, a car is a depreciating asset, and a stock is an appreciating asset. Oftentimes all assets are not split 50/50, and sometimes a trade of assets will be made. Keep the long-term growth rates of assets in mind when splitting. You’ll also want to consider each asset’s cost basis and transaction costs to ensure you’re making an apples-to-apples comparison.
At Creative Planning, we understand how challenging navigating all aspects of a divorce can be. That’s why we focus on providing you with confidence and security by helping you determine your financial need, gain an understanding of your options and make decisions that are in the best interests of you and your family. For help dividing assets in a divorce, or with any other financial matter, schedule a call.