As someone contemplates divorce, one of the most common concerns, after custody of the children is whether either spouse will be able to continue living in the marital home. Most likely, the home has significant emotional meaning. It could represent heartfelt memories of raising your family during happier times or some other happy occasion, such as a wedding which was hosted there. It could also represent financial status as it may have taken years to complete various improvements in the home.
It could even provide the hopes of a smoother transition by trying to maintain the “status quo” as much as possible for your children (and yourself too). While these reasons are certainly understandable and meaningful, it is crucial to also consider the financial factors in deciding whether to stay in your home. The following are some factors which everyone should think about before reaching a decision.
The home can often be one of the largest assets on the marital balance sheet which can create a potential cash flow issue if you are the one remaining in the home. If you owned the home jointly while married, one party would need to “buy out” the other in order to stay. This can potentially have a negative short-term and/or long-term financial impact on the party who chooses to remain. Buying out the other party means you elect to forego other liquid assets (in the property settlement) to retain your spouse’s share of the equity in addition to yours.
As an example, if a couple has a $1MM home (with no outstanding mortgage for simplicity) and the wife wished to remain in the home, it would require her to give up $500k of other assets in order to buy the husband out. Another option is to obtain a mortgage on her own, which could be more challenging with only one income and half the marital assets. The $500k of assets she gives up could be crucial for her short-term liquidity and/or long-term financial security. This could be less of a concern if the wife has a high-income career or if any additional marital assets she receives in the property settlement were enough to provide the necessary annual income for her. Nonetheless, it is a crucial decision given the potential impact on cash flow.
Any home will be accompanied by significant monthly outflows. Monthly costs associated with the home can include real estate taxes, utilities, insurance, ongoing maintenance such as landscaping, painting, and even miscellaneous repairs or improvements. If you have an outstanding mortgage on the home, this will put an additional strain on the monthly cash flow. Review in detail what the monthly costs were over the last year and if any additional costs will be necessary over the next year or two.
Have you been putting off replacing the air conditioning or maybe it is time for a new roof? Will these monthly and one-time costs fit comfortably into your new budget? If not, moving to a new home could possibly provide you with an opportunity to downsize and reduce those monthly outflows to better align with your new budget.
When a married couple (filing jointly) sells their primary residence, the sales proceeds (net of certain selling costs) are potentially taxable to the extent they exceed the adjusted cost basis in the home. This is the estimated gain in the home. As a married couple (filing jointly) if you meet certain requirements, you may be entitled to a principal residence exclusion of $500k to help mitigate the taxable gain. If there is an expected tax liability upon selling (pre-divorce), the associated tax liability is also included on the marital balance sheet.
When you buy out your spouse’s share of the marital home, his/her portion of the home’s original cost basis (and adjustments to the cost basis) is added to yours. That means that any appreciation in the home’s market value during your years of marriage is now yours – as well as the associated tax liability. And to make matters worse….if you sell the home post-divorce, the actual tax liability on those gains may be greater, since your principal residence gain exclusion amount would likely be $250k (single filing tax status) instead of the $500k you may have qualified for as a married couple.
It may not be a material concern if your home’s fair market value didn’t appreciate by more than $250k; however, if it has, it may be an unpleasant surprise when you decide to sell your home 5 years later (after the kids are out of the house). There are some ways to protect yourself if you plan to stay in the home. Be sure to consult with a financial professional (preferably a CDFA®) when determining the most tax-efficient division of marital property. When discussing with your attorney how the marital assets could potentially be divided, you need to factor in any future income tax implications of keeping the home.
Remaining in the marital home is often viewed as the “safest” route when considering other viable options. Remaining close to friends and neighbors can be additional support and very important to everyone. The idea of relocating – searching for a home, selling the existing home, packing, and starting over somewhere can contribute additional stress to an already emotionally exhausting period, even if it is moving within the same town.
Alternatively, the marital home may have “baggage” and it may be a better idea to find a home that provides a fresh start while better suiting your needs (i.e., specific features, layout, location). Perhaps your current home was your spouse’s dream home, but not yours. It may also have more rooms than you would like to manage going forward (putting aside the associated costs). Finding a home that best suits your future needs, style and budget could be a healthy way to turn the page and start a new chapter in your life.
How to sort it out
When starting this process, the best way to approach it is to first consult with your attorney to determine the possible options for property settlement and marital support. Keep in mind that these are only estimates at this stage of the divorce proceeding. Once you have this information, you should sit down with a financial advisor/CDFA® to determine what you can comfortably afford with your projected net worth and income. If you can comfortably remain in the marital home post-divorce (after factoring in monthly savings) and that is also your preference for other reasons, then you can spare yourself the additional stress.
If the numbers aren’t ideal for remaining in the marital home, find out what would be an appropriate amount for you to spend on purchasing a home and monthly related costs. Does it make sense to take out a mortgage? If so, will you qualify for a mortgage? Obtaining a market analysis on your home during initial proceedings will assist in estimating any potential income tax liability that may be due upon sale.
Conduct your search using the criteria that is important to you. Be sure to set aside additional funds for decorating, and any necessary repairs/improvements. It is important to begin these discussions with your attorney and financial advisor/CDFA® early in the divorce proceeding to allow sufficient time to review the analyses and begin searching for a home if necessary.
The decision whether to keep or sell the marital home is both an emotional one as well as a financial one. It should be discussed as a part of the overall property settlement. Take your time with this decision and utilize all resources available to you including your attorney, accountant, and financial advisor. The emotional wounds will heal over time, but the negative financial impact of staying in a house that you cannot afford is one that will not fix itself over time.