You worked with your attorney to identify and quantify marital assets. You know what everything is worth, so assigning and distributing marital assets should be a piece of cake, right? Not so fast. Please be careful.
Two major issues to consider when dividing marital assets: taxes and liquidity.
As a tax CPA earlier in my career, what I remember most were my clients getting a surprise tax hit. It was the worst part of the job, especially when there was nothing I could do to help. Unfortunately, if you’re sitting with your tax adviser next March telling them something for the first time, the next words out of their mouth may make you angry and sad. Without getting too deep in the weeds of income tax law, here are my best pieces of advice I can offer.
- Anything that puts cash in your hand could be taxable. Find out now.
- Estimate your taxes before you settle your divorce. Pay it in or set it aside.
- Different assets are taxed differently. For example, real estate and investments with identical values can have very different taxes.
- The more income you pile up in one year, the higher your taxes will go.
Uncle Sam always gets the first bite at the apple. Plan ahead with good advisers and you won’t be surprised what you have available to use after taxes.
This is just a fancy way of saying, “Can you turn something into cash quickly and easily?” Is it liquid or illiquid? For example, do you want the vacant lot appraised for $50,000 or the investment account worth $50,000? That depends on your needs and comfort with the asset. If the vacant lot won’t sell right now but you’re a real estate expert, you may be fine with getting that in your divorce. On the other hand, if you have three mouths to feed, you may want the investment account in case you need cash in a couple days (net of taxes). Your tolerance for illiquid assets will probably be driven by your monthly cash needs.
Taxes and Liquidity Together
You should consider these issues together. For example, let’s say you have a home that’s worth $200,000 and investments worth $200,000. Which do you want? That depends. The home could be illiquid if the real estate market is poor. Maybe you can’t sell it even if you want to. Let’s say you want to keep the home. It’s the family home and you like it. But, can you afford it? Even a liquid home won’t generate cash. In fact, it will eat thousands of dollars a month in mortgage, taxes, insurance, and repairs. Maybe the math simply doesn’t work anymore. Here’s the good news – if you sell it and follow the rules, there’s probably no income taxes. Generally, a personal residence can be sold tax-free.
What about the investments? You can’t live in them, but they’re probably liquid. Two hundred thousand dollars goes a long way. Don’t forget about the tax haircut though! You won’t walk away with $200,000. Maybe it will be more like $150,000. You’ll want to get detailed tax advice specific to you.
The Bottom Line
There are no quick and easy answers to assigning and distributing divorce assets. You must take each asset on a case-by-case basis, considering not just the value but also taxes and liquidity. All assets are not equal.
If you would like to learn more about this, watch this video.