Dividing Equity When Couple Splits

By VICTORIA FELTON-COLLINS and VIOLET WOODHOUSE

May 10, 1992 12 AM PT

SPECIAL TO THE TIMES

Wrangling over the house is practically a universal pastime among divorcing couples. Not only is a house the largest and most valuable asset you are likely to have, but it’s also loaded with symbolic meanings and emotional attachments.

A home can represent the commitment to partnership between husband and wife, a place where the children grew up or a refuge from the demands of life. Perhaps it stands for a connection to the community--or to the future generations of your family to whom you hoped to give it.

In many divorces, especially when the couple has children living at home, the custodial parent buys out the other spouse’s interest. Commonly, the spouse who is keeping the house pays the other spouse his or her share of the house’s equity value. On the surface, it seems fair. This scenario, however, fails to consider many other costs of homeownership.

For example, say Juan and Maria purchased their home 10 years ago for $50,000. They added a room for $10,000 and made no other improvements. Their tax basis, then, is $60,000. The current fair market value of the house is $250,000. To sell it will cost $20,000 (8% of the fair market value).

They refinanced the house a few months ago and have debt against it for $90,000. This leaves the couple a total equity of $160,000 in the house.

Maria wants to keep the house to prevent disruption of the children’s lives, and then plans to sell it in five years, when both children will be in college. Juan and Maria used only marital property when they purchased the house, so they agree that each has a 50% interest in the house.

If Maria and Juan were unable to reach an agreement on dividing their property and left it to a judge, the judge would use only the equity value in dividing the house. Thus, if Maria insisted on purchasing Juan’s share of the property, the judge would order her to pay him $80,000, or let him take $80,000 more of the marital property in the overall division of their assets. And judges aren’t the only ones who think this way. Maria’s attorney would probably advise her that she’d have to pay Juan $80,000 to keep the house.

But this figure doesn’t include other costs Maria would eventually encounter by keeping the house. When she sells it in five years, she’ll have to pay costs of sale (8% of the fair market value) and taxes on the gain (profit). And those costs can really add up.

If Maria bought out Juan based on the after-tax/after-sale value (the equity value less the costs of sale and taxes on gain), she’d have to give him only $46,200, compared to the $80,000 owed from a split of the equity value. And this is fairer--Maria should not have to pay the costs, or at least all of the costs, alone. She and Juan bought the house together, and Juan is receiving a share of the appreciation in the settlement--he should also pay a share of the sales costs and taxes.

But what if Juan insists on getting equity value? Then Maria ought to modify her plans and they should sell the house jointly. If she really wants to keep the house and cannot get Juan to accept the after-tax/after-sale value, Maria could try a few negotiating tactics, such as:

--Offer to split the difference between the after-tax/after-sale value, and the equity value.

--Ask Juan to pay some of the potential tax liability (such as 30%), but not 50%.

--Have Juan discount the price by the broker’s fees--that is, reduce the amount Maria would have to pay him by the estimated broker’s cost in the event of a sale--while not pushing the tax issue.

Maria may have to hold a hard line to get the price she wants. But even if she winds up paying the equity price, at least she’ll know the costs she will bear in the future and will have a realistic expectation of what she will receive from a future sale of the house. Maria must keep in mind, however, that if she buys out Juan’s share and he discounts the equity value by only he cost of sale, and Maria eventually sells the house, she may lose money (in relation to Juan) because of the tax liability.

This article is excerpted from “Divorce and Money: Everything You Need to Know About Dividing Property” by Violet Woodhouse and Victoria Felton-Collins, with M.C. Blakeman (Nolo Press, 1991: $19.95) available in bookstores or by calling (800) 992-6656.

Definitions of Key Terms Used in Calculating Costs

Current fair market value--The amount you can realistically expect to sell the house for, based on the sales prices of similar houses in your neighborhood. You can obtain fair market value estimates from a real estate agent free of charge.

Sales costs--For a ballpark estimate, multiply the current fair market value by 8%.

Equity value--The fair market value less whatever debt is connected to the house. The debt equals what you owe to any lenders (mortgages or home equity loans) plus any liens (legal claims on file) on the house.

Share of the house--If either spouse used premarital income (or other separate property, such as a separate inheritance) to purchase the house, that spouse may own more than 50% of it. If you’re unsure, assume the house proceeds will be split 50-50.

Tax basis--The basis is the dollar amount used by the IRS to determine if you make or lose money on the sale. The basis is the original purchase price plus the cost of any capital improvements--items adding value to the house, such as a new bathroom or den, a security system or extensive landscaping, but no repair costs--minus any tax benefits (such as rollover of gain from prior homes or depreciation taken for a home office) you have taken.

Financial Reality Original purchase: $50,000

+Improvements:$10,000

Tax basis: $60,000

Fair Market Value: $250,000

-Cost of Sale: $20,000

-Tax basis:$60,000

Gain: $170,000

Tax bracket: .28

Taxes on gain: $47,600

Equity value of house: $160,000

-Cost of sale:$20,000

-Taxes on gain:$47,600