Add House Agreement to Divorce Papers to Preserve Tax Exclusion

Question: My husband and I divorced in January 1998. We had planned to sell our home as part of the divorce, but that changed when we discussed the situation with our grown daughters and found out how much our home means to them. I tried to be as amenable as possible, because I had requested the divorce and felt guilty about it, so my ex and I became tenants in common.

I am denied access to the house for fear I’ll take something, because I took a few items one day without telling him I was there. The locks were then changed. My former husband continues to pay the mortgage and taxes. If the home is sold, I would receive 40% of the sale. Do I still qualify for the $250,000 home sale profit exclusion on my income taxes?

Answer: Perhaps. But you may need to act quickly if you don’t want to find yourself locked out of the tax benefit, in addition to being locked out of the house.

Normally you have to live in a home for two of the five years preceding its sale to qualify for a $250,000 exclusion on any profit from its sale.

There’s an exception for couples who split, however. If one spouse is granted exclusive use of the home as part of a written separation agreement or divorce order, then the other spouse is treated for purposes of the home sale rules as though he or she were still living there. Once the home is sold, each spouse can qualify for the $250,000 exclusion.

This exception helps prevent divorced parents from having to sell off the family home just to lock in the tax benefit. That ensures that the kids can grow up in a familiar place.

The fact that your kids are grown doesn’t change your eligibility. But remember: The arrangement granting your ex exclusive use of the home must be in writing, and to be safe it should be part of the divorce agreement, said Ginita Wall, a San Diego financial planner and tax expert.

If it wasn’t--if you and your husband made this decision after your divorce and the arrangement wasn’t part of the written order, as seems likely from your letter--you can go back and amend the order, Wall said.

But you should act now, because you can’t make the amendment retroactive. In other words, any time that elapses between your divorce and your putting the agreement in writing won’t be counted as part of your “two years out of five” residency requirement, Wall said. The minute you get the agreement added to your divorce order, though, the clock begins ticking again.

If your ex decides to sell the home and you don’t have the agreement in writing, you may owe capital gains taxes when the home is sold.

If things are still touchy between you and your ex-husband and you’re not sure he’ll agree to the plan, you might start by returning whatever it was that you took from the house. The gesture might restore a little of the goodwill you lost on your last visit.

Don’t Cash Out Stocks Years Before Retirement

Question: Your answer to the person who wanted to know whether she should sell stocks in her daughter’s college fund has me a little confused. You mentioned that financial planners generally advise not to have money in stocks that you will need within a few years.

I am about three years from retirement, and I had been thinking that dividends and capital gains from my tax-free bond mutual fund and my domestic hybrid mutual fund would be major contributors to my retirement income. But it sounds like planners would say I should sell both and put the money in money market funds one to two years before I retire. Is that correct?

Answer: Good heavens, no. Your retirement, let us hope, will last more than a couple of years. You’re likely to need the growth potential of stocks to give you long-term returns that beat the rate of inflation. Switching to an all-cash portfolio would almost guarantee that your purchasing power would decline as you age, because inflation and taxes probably would eat up most if not all of your gains.

Some leading financial planners do recommend you beef up the amount of cash in your portfolio as you approach retirement so you’re better able to withstand any stock market storms without having to sell your equities at a low point.

Generally, they recommend keeping two years’ worth of expenses in cash. That benchmark may be high for people who expect most of their income to come from guaranteed sources such as Social Security or a pension. You might consider subtracting those sources of income from your expected expenses over the next two years, and keep that amount in cash.

These are issues you probably should discuss with a good, qualified financial planner. Even die-hard do-it-yourselfers can benefit from a professional review as they approach retirement to make sure their portfolios and their plans are on track.

You can find information about choosing a financial planner at https://www.latimes.com/finplan. Two of the largest no-load mutual fund companies--Vanguard Group at (800) 547-3332 and T. Rowe Price at (800) 541-4986--also offer a one-time review of your investment plans for $500.

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