Divorce and the Family Home

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One of the main issues that often needs to be decided in a divorce is what to do with the family home. Here is an overview of the most common approaches:

Sell the Home.  It is very common to sell a home as part of a divorce.  This is the simplest and easiest approach, although it may not necessarily meet your family’s interests as well as some of the other options, particularly if children are involved.

Advantages of selling the home:

  • It (hopefully) provides cash for each spouse. The cash can help someone get into a new home or can be used as funds for one spouse to “buy out” spousal support or to pay a property settlement.
  • You do not need to decide how much the home is worth because the home will sell for whatever it sells for. In a buyout it’s important to decide how much the home is worth, which can sometimes be difficult, particularly if you have a unique property.
  • It eliminates the need to remove someone from the mortgage.
  • It disentangles former spouses from one another.

Disadvantages of selling the home:

  • It may be important to maintain the family home for the stability of a person or the children.
  • It may be not be affordable to purchase a new home and/or your new mortgage payment may be much higher than your original mortgage payment.

Buyout.  A buyout occurs when someone keeps the home and “buys out” the other person’s share of the equity.  This can happen by doing a “cash-out refinance” or by transferring other assets.  It’s important to specify when the mortgage will be refinanced so that the other person’s name is removed from the mortgage.  If the person keeping the home cannot fund the buyout and remove the other person’s name from the mortgage, the judgment typically states that the property will be sold.

Advantages of a buyout:

  • It allows someone to maintain the family home for the stability of the children or themselves.
  • The person keeping the home does not have to deal with moving, which can be an overwhelming process, particularly when it’s happening as part of a divorce.
  • When structured correctly, a buyout may enable the other person to purchase a home so that both people have a home following the divorce. (This would also be true of selling a home.)

Disadvantages of a buyout:

  • There might not be enough assets to fund the buyout. Even if there is, one person may end up with the bulk of their assets being tied up in home equity and have no retirement funds, for example.
  • It’s important to determine the value of the property. Sometimes this is easy to do, but sometimes this can be challenging.  People usually determine the value of the home by obtaining one or more “CMA’s” (comparative market analysis) from a realtor, or by hiring an independent real estate appraiser.  Sometimes people will obtain multiple CMA’s and/or multiple appraisals and average them.  With that said, you won’t truly know how much the home is worth unless you sell it.
  • The person keeping the home will be responsible for all of the real estate commissions if/when they sell the home in the future.
  • A refinance will be necessary if people are joint on the mortgage. If the person keeping the home is the only one on the mortgage, then no refinance will be necessary.  However, a cash-out refinance might still be needed in order to pay the other person their share of the equity.

Co-ownership.  People sometimes decide they will continue to jointly own a property following the divorce.  Co-ownership is probably more common than you think – however, it’s also the most complicated of the arrangements.

Considerations in co-ownership:

  • Are the two of you capable of effectively owning a property together after you are divorced?
  • If it’s the family home, who will live there?
  • If it’s a rental property, who will be responsible for dealing with it?
  • How will the monthly expenses get paid? What happens if repairs need to occur?  What happens if you can’t agree if a repair is needed?
  • How long will this arrangement last? It’s very important that a co-ownership arrangement is very detailed so that it addresses all contingencies and describes how and when people can end the co-ownership.

Advantages of co-ownership:

  • It allows someone to maintain the family home for the stability of the children or themselves for some period of time. People will often co-own a property until a child gets through a certain school.
  • You may consider the property to be a good investment.
  • People don’t typically need to refinance the mortgage if they are co-owning the home (although there may be reasons to do so).

Disadvantages of co-ownership:

  • Both people’s equity is ‘tied up’ in the property. This doesn’t necessarily matter for the person remaining in the home, but it could prevent the other person from being able to buy a new home.
  • Your credit will be negatively impacted if you remain on a mortgage and then the person who is supposed to pay the mortgage misses a mortgage payment.
  • What happens if there is a disagreement or if someone changes their mind and decides they no longer want to be co-owners?

These are the most common approaches and considerations to dealing with a home in the divorce.  With that said, there may be other approaches and considerations in your particular situation.  Here’s the good news: Once you decide which approach makes sense in your situation, the “details” are usually relatively easy to determine.  An experienced mediator or attorney can help identify and work through these details to develop a framework that makes sense for your family.

What is Tax Discounting?

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“Tax discounting” is a (relatively) simple but important concept that frequently comes up in the divorce context.  Although the concept itself is fairly straightforward, as with many things, the details can be pretty complicated.  This article is designed to give you a general overview of the topic of tax discounting.  Your mediator, attorney or CPA will be familiar with these concepts, so don’t feel like you have to remember all of this!  This article is provided as general introduction to this topic and should not be construed as tax advice.  You are encouraged to discuss tax discounting further with your CPA or tax professional if it may be relevant to your situation.

Tax discounting refers to reducing the value of an asset by the anticipated tax liability associated with the asset.  Think of it this way: If you had to pay a $1,000 bill tomorrow, would you rather have $1,000 in cash or $1,000 in your 401(k)?  The (likely) answer is that you’d would rather have the cash.  This is because if you had to cash in $1,000 from your 401(k), you would not receive $1,000 – you would receive much less after taxes.  (There would also be a 10% penalty if you were not 59.5 years old, but that typically does not get factored in.)

When it Matters: Equalizing Pre-Tax with Post-Tax Assets.  If you are trading pre-tax assets (401k’s, IRA’s, etc.) for post-tax assets (cash, Roth IRA’s, home equity, etc.), then tax discounting will usually be applied.  For example, imagine your only two assets are $50,000 in retirement and $50,000 in cash.  Are these assets equal?  If you apply tax discounting, then the answer is ‘no’.  Again, this is because if you cashed in the $50,000 in retirement you might pay 25% taxes, which would leave you with $37,500.  It should be noted that not all professionals agree that tax discounting is appropriate.  Oregon lawyers and mediators usually apply tax discounting, although not always.

Other situations where some version of tax discounting may apply include:

  • Taxable investment accounts.  If you have stocks, bonds, etc., that are not held in a retirement account, these investments might have either short-term or long-term capital gains.  Short-term capital gains are taxed at ordinary income rates.  Long-term capital gains are taxed at capital gains rates (0%, 15% or 20%).
  • Rental/Investment Properties.  Real estate that is held for investment is subject to capital gains taxes when it is sold.
  • Businesses.  Businesses that are sold are subject to capital gains taxes at the time of sale.

Note: In Oregon, tax discounting usually only applies to the sale of businesses and real property if the sale is certain to happen in the relatively near future.  As with just about everything, the specifics of your situation should be discussed with your attorney.

Importance of Tax Rate.  When we are dealing with tax discounting, the assumption that you make about the tax rate is very important.  Sticking with the $50,000 retirement example, if we assumed a 19% tax discount (10% Federal, 9% State), then $50,000 is only “worth” $40,500.  If we assumed a 42% tax discount (33% Federal, 9% State), then $50,000 is only “worth” $29,000.  Using this example, you can see the importance of choosing an accurate tax rate.  Unfortunately, this is not necessarily the easiest thing to determine accurately, particularly since it requires speculating what someone’s future tax rate will be, not just their current tax rate.  The following terms may be helpful in understanding some of the complexities of determining your tax rate.

Marginal Tax Rate vs. Average Tax Rate.  When people think of their tax rate, they usually think of their “marginal” tax rate.  Marginal tax rate is the tax rate that applies to all dollars earned in a particular tax bracket; this is your “top” tax rate.  However, you don’t pay your marginal rate on all money that you earn – you pay a lower rate on amounts you earn in a lower tax bracket.  For example, in 2016 someone filing “single” will pay 25% federal income tax on amounts earned between $37,651 and $91,150.  But, that same person pays 10% on earnings between $0 and $9,275, and 15% on earnings between $9,276 and $37,650.  So a person who earns $40,000, will only pay 25% on $2,349 ($40,000 – $37,651).  Note: This example does not account for dependency exemptions, personal exemptions, itemized deductions, etc.

The average tax rate is the total tax you paid divided by your total income.  So if someone earns $40,000 and pays a total of $5,500 in taxes, then their average tax rate would be 13.75% even though their marginal tax rate is 25%.

You should discuss whether to apply your marginal tax rate or average tax rate with your tax professional, attorney or financial advisor.

“Grossing Up.”  Often someone will owe a property settlement and the only asset available to pay the settlement with is an IRA or 401k.  Since we know that retirement accounts are worth less after you discount them for taxes, the question is, what is the amount needed to get someone a certain amount after taxes are factored in?  Luckily, there is an equation for this.

The equation is: (Amount owed) / (1 – Tax rate)

Example: $50,000 / (1 – .24) = $65,789

This means that if we need to get someone $50,000 and that person’s assumed tax rate is 24%, then it would require transferring $65,789 from a 401k.

Avoiding The Issue.  In practice, we usually try to divide assets in a way that evenly distributes tax consequences between the parties so that you can avoid having to deal with tax discounting.  If both people evenly share the tax consequences, then we don’t necessarily care what the tax consequences are because they will apply (more or less) evenly to both people.

Based on the above examples, you can probably see the significance of assuming an accurate tax rate.  Unfortunately, this is a difficult thing to accurately predict.  It requires us to accurately assume 1) someone’s future income and, 2) what tax rates will be in the future.  If the assumptions are inaccurate, then someone can potentially ‘overpay’ or ‘underpay’ significantly.  How can we avoid this?  This can be avoided by not trading one kind of asset for a different kind of asset.  In other words, this can be avoided by splitting each type of asset class in half.  Note: It may not always make sense to split an asset in half.  Further, “splitting the asset” refers to splitting the “marital portion” of the asset.  If someone has a premarital retirement account, the premarital portion wouldn’t typically be split (although it could be).   

Continuing with the above example, we can avoid tax discounting if each person receives $25,000 in retirement and $25,000 in cash.  If each person receives half of each of these assets, then no tax discounting is required because each person is getting half of everything, including the tax consequences.

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This is a general overview of this subject which is designed to give you a basic understanding of the issue of tax discounting.  This article is not tax advice and should not be construed at such.  If you need tax advice, you should consult with your CPA or other tax professional.  Further, it is important to realize that all situations are different and that it might not be appropriate to apply a tax discount in a particular situation.

Picking the Right Process – Uncontested Divorce vs. Kitchen Table Mediation

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Despite what popular culture tells us, it is very common for people who are getting a divorce to reach their own agreements.  Typically people who reach their own agreements come up with the “big picture” agreement but still need some assistance fine tuning the details or drafting documents.  It’s at this point where one person will usually call a lawyer or mediator and say they want to do an uncontested divorce.  Although an uncontested divorce may make sense in your particular situation, kitchen table mediation should be considered as well.

Uncontested Divorce.  An uncontested divorce involves one lawyer working with one client to draft the agreement the parties have reached.  Alternatively, if no agreement has been reached, then the lawyer may work with the client to create a proposal to give to the other spouse.

The lawyer in an uncontested divorce only represents the spouse who hired him or her and cannot represent both people.  The job of the lawyer is to provide legal advice to the client who hired the lawyer and to draft the documents on his or her behalf.  Clients who call about an uncontested divorce are often disappointed to learn that one lawyer cannot represent both clients even if the clients have reached their own agreement.

You can learn more about uncontested divorce here.

Kitchen Table Mediation.  In kitchen table mediation both clients work with one mediator to fine tune the agreements they have already reached.  If the clients have not already reached their own agreements then the mediator can work with both of them to create a mutually beneficial settlement.  Once a complete agreement has been reached the mediator drafts the documents on behalf of both clients.  The mediator works with both people but does not represent either person and cannot provide legal advice to either person.

You can learn more about kitchen table mediation here.

Uncontested vs. Kitchen Table Mediation.  The main difference between these two processes is that both clients participate in the kitchen table mediation whereas only one client participates in the uncontested divorce.  One of the potential issues with an uncontested divorce is that the person who did not hire the lawyer may be concerned that the documents were drafted by “their ex’s lawyer.”  This may make the non-hiring spouse suspicious and cause them to hire their own lawyer to review the documents.  Although there is nothing wrong with this, it usually creates a certain level of mistrust and often adds more expense than the clients were planning on.

Kitchen Table Mediation tends to cost less and take less time for a couple of reasons.  First, in kitchen table mediation both clients receive the same information at the same time from a neutral source, i.e., the mediator.  Instead of getting conflicting advice, clients receive neutral information which they can evaluate for themselves.  Next, both clients get the benefit of offering input in the drafting of the judgment instead of one lawyer drafting the documents on behalf of just one person.  Since the

mediator worked with both clients it is more likely that the documents will reflect the agreement that the parties reached (versus one lawyer drafting on behalf of his or her client).

The Verdict.  If both people are willing to participate in the process then kitchen table mediation usually makes more sense than an uncontested divorce.  However, if someone is not willing to come and meet with their spouse and the mediator then an uncontested divorce may be the better option.

Do I NEED a mediator?

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Occasionally people will ask something like this: “We have figured out our entire agreement. Do we really need a mediator?” The answer is – no, you do not need a mediator – but it’s probably a good idea to have one. There are usually two main concerns someone has when they ask this question.

Concern #1 – We are getting along really well – we don’t want a mediator (or lawyer) to screw that up!

This is a fair concern. Rightly or wrongly, lawyers have a reputation for creating arguments rather than solving problems. However, a mediator is not acting as a lawyer (although many mediators are also lawyers). The mediator’s job is to work with both clients to help develop an agreement that will work well for each of them. A really good mediator will help identify shared interests which will “enlarge the pie” for both clients. In short, a skilled mediator should improve the situation, not make it worse.

Concern #2 – We have figured everything out – we don’t actually need to mediate anything!

You are probably right at a high level. However, there are always at least some details that have been overlooked. Instead of mediating, the mediator in this situation can help you fine-tune the agreement you have already reached or figure out if there is anything you have overlooked.

Here’s an example: It is common for people to decide that one person is going to keep the house and buy the other person out. Here is what they may not have considered:

• How will they get the other person off the mortgage and in what timeframe?
• What happens if the other person cannot be removed from the mortgage?
• Should the non-owner be removed from the deed? What happens if the owner dies while the non-owner is still one the mortgage if the non-owner has been removed from the deed?

The mediator in this situation isn’t really mediating, per se. Rather, he or she is acting as a creative problem-solver to help you optimize the agreement you have already reached.

So why hire a mediator in this situation?

Reason #1 – This is probably your first or second divorce. The mediator has dealt with hundreds of divorces.

Experience counts for a lot. Even if you think you have covered every possible detail, the mediator will almost certainly offer some insight or help generate some idea that you had not considered.

Reason #2 – The “do-it-yourself” paperwork is more complicated than it seems.

There are several options for online divorce paperwork. The forms you fill out yourself are really only suitable for very straightforward situations with little or no complexity. You can also pay an online service or a paralegal service but these are often riddled with errors and not sufficient in highly detailed agreements.

A mediator who is also lawyer can draft all of the paperwork for you and submit it on your behalf.

In short, a mediator can provide valuable insight even if you think you have already figured everything out. A mediator can also prepare the paperwork on your behalf.