Nancy Hetrick 2013-04-04 07:17:35
Divorce Settlements – 4 Common Mistakes of the Principal Residence Nancy Hetrick is the owner of Divorce Financial Strategies, LLC and a financial advisor with Clarity Financial LLC. As a certified divorce financial analyst [CDFA™], she assists clients and their attorneys to understand how the financial decisions he/she makes today will impact their financial future. She has over 13 years of experience in both investment management and financial planning. Nancy is also an accredited wealth management advisor (AWMA), an accredited asset management specialist (AAMS), a chartered mutual fund counselor (CMFC) and a trained mediator. For more information, see her website at www.nancyhetrick.com or contact her at 602-349-0164 or firstname.lastname@example.org. In a large percentage of divorce cases, the principal residence is often the largest asset the couple has. Determining division is fraught with financial perils that you must be aware of to serve your client properly. 1) Repayment of the First-time Homebuyer Credit (FTHBC) Don’t forget that if your client bought a home in 2008, 2009, or 2010 they may well have taken advantage of the FTHBC. If they used the credit in 2008, they will be paying back money each year of the loan until repaid in full or until the property is sold. With so many homes in Arizona worth less than the mortgage amount, some are opting to keep the home and turn it into a rental. Be aware that if the home ceases to be a principal residence, the FTHBC is due and payable in full that year! If one spouse deeds the home to the other, the receiver is now responsible for the entire credit and this should be considered when valuing the equity in the home. 2) Cost Basis and Capital Gains In long-duration marriages, there could be considerable equity in a principal residence. Knowing the cost-basis is critical to ensuring a fair division. Single taxpayers can exclude $250,000 from capital gains and married taxpayers $500,000 every two years for the sale of a principal residence. Let’s look at an example. Joe and Shirley have owned their home for 20 years. They bought it for $100,000 in 1983 in the historic district and have made $25,000 worth of improvements giving them a basis of $125,000. They are now planning to divorce and Joe is planning to keep the family home. It currently appraises at $500,000 resulting in unrealized capital gain of $375,000. Now their home is paid for so the value is $500.000 and Joe uses their accumulated savings to pay Shirley $250,000 to buy her out. One year later, he realizes he really doesn’t want a house that large and decides to downsize. Not even thinking about it, he sells the home for $500,000 and because he is now a single taxpayer in the top bracket, his 23.8% capital gains rate (new for 2013) applies to $125,000 of his gain and he is socked with a tax bill of $29,750! If he had sold the home before the divorce, the total gain would have qualified for the marital exclusion. His half of the home wasn’t so equal after all. 3) Not requiring the other spouse to refinance Bill and Mary have decided that Mary will keep the marital home and Bill will sign over the deed to Mary. The home is worth almost exactly what the mortgage is so no buyout is necessary. Mary won’t have any liquid savings so she can’t qualify to refinance the loan that would require a 20% down payment so Bill agrees to let her make payments on their existing mortgage. One year later, Bill applies for auto financing and the finance manager declines his application. “What? Surely this must be a mistake!” It turns out Mary quit making the mortgage payments 6 months ago and is planning to let the house go into foreclosure and then she’ll move in with her new boyfriend so she won’t really need a good credit score anyway. Sorry Bill. Your credit has just been ruined for the next several years and there’s not a darn thing you can do about it. Don’t let this happen to your client. Insist that if the other party can’t qualify to refinance the house, the house must be sold! Period!! 4) Letting your client keep a house they can’t afford We all know that one of the most common situations is a spouse, usually the woman, who insists that she wants to keep the house. Please, please, please, be sure that you have reviewed her budget with her and feel confident she’ll be able to afford it. Better yet, refer her to a certified divorce financial analyst, CDFA to give her the in-depth financial guidance she needs. I work with too many women after-the-fact that are near bankruptcy because the cost of their home is eating them alive! Let me be the bad guy and show them in black and white what their future looks like if they keep the house. I’ll show them their cash flow and net worth for the next 30 years and it will be very clear. Getting a divorce is hard enough without realizing down the road that you really screwed up when it came to a settlement. Help your clients to do the right thing and call in a CDFA if there are any grey areas. You’ll be glad you did.
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