On average, Americans have $150,506 of wealth tied up in their homes. So you’d think that couples who once bought a house together would preserve what’s likely their biggest asset with care, no matter how heated things get. But divorced couples are often confused about how to handle the house they once bought together and fail to deal with it responsibly, resulting in serious financial consequences.
“I sell a couple of hundred homes a year that are foreclosed properties for banks and government, and a huge chunk of those are as a result of a divorce,” says Tim Ray, a top agent in Kansas City, Missouri who regularly helps divorcing couples sell their home.
“People just throw their hands up because they don’t know how to deal with their situation.”
Rather than treat your largest financial asset with reckless abandon, review these top considerations for navigating your divorce settlement options related to the house we’ve compiled with the help of real estate attorneys and legal experts in family law.
What is a divorce settlement, and how does property factor in?
A divorce settlement is a legal document between a divorcing couple that formally outlines the terms of the divorce regarding child custody, alimony, property division, and more. Even in the most civil of divorce proceedings, you’ll need to have a formal divorce settlement prepared.
While no two divorces are the same, creating a settlement typically follows a standard timeline:
- File a complaint, kick off the divorce proceedings.
Either you or your spouse writes up a petition, or complaint, with a lawyer. The petition explains why you want a divorce, as well as how you want to divide assets.
- Complaint is served and answered.
The petition is filed in court, as well as formally served to your spouse. Your spouse is required to answer the complaint with a response; which typically includes how your spouse would prefer to divide the assets.
- Exchange of information.
You and your spouse exchange information around finances, property, and income.
- Mediation and settlement.
Some states legally require divorcing couples to enter mediation discussion. In other states, mediation is voluntary. If you and your spouse can agree on all assets, you’ll share a settlement agreement with the court.
- Approval or trial.
If the judge agrees with the settlement agreement, a formal divorce decree is drawn up. If you and your spouse can’t come to an agreement, the divorce will go to trial.
If you and your spouse (soon to be ex-spouse) own property together, deciding what you do with it in your settlement is one of the bigger and more complex challenges you’ll face. You’ll want to make an informed choice based on your finances, your relationship with your ex, real estate market conditions, and the impact on your children. Most divorced couples will choose between these options:
- Sell the house and split the proceeds.
You both might decide to move on immediately and sell your home. From there, you’ll make a legal decision to divide up the earnings equitably upon closing.
- Buy out.
Perhaps one of you wants to stay in the home, while the other leaves. Instead of selling, one partner can buy out the other’s interest in the house. This commonly happens in instances where children are living at home, or the market conditions aren’t ideal for a sale at the time.
- Keep the house and sell at a later time.
In a booming rental market, you and your ex might decide to hold onto your home and rent it out. Alternatively, you might decide on an alternative living arrangement where you keep the property jointly post-divorce and wait for the right time to move forward with a sale.
As you work to incorporate the division of property into your divorce settlement, there are several factors to consider as you move forward that we’ll review next.
Figure out how much the house is worth
Whether you sell the house or agree to a buyout, you’ll have to find out how much your property is currently worth.
To coordinate a buyout, courts typically require a professional home appraisal to determine a home’s fair market value in a divorce. They need an official opinion of value to decide what’s owed to the spouse who’s selling their stake.
If both spouses order separate appraisals and the appraised values aren’t the same, a judge may be called in to make a decision or compromise. (This can happen in less amicable divorces when the person buying the home wants the lowest appraisal possible to mitigate what they owe, while the person selling their share is motivated to get the highest appraisal possible to maximize what they’ll receive.)
Alternatively, if you’re putting the house on the market, you may only need a comparative market analysis from your real estate agent to set a list price. However, if you and your ex-spouse can’t agree on an asking price, a home appraisal may be necessary to break a stalemate.
Don’t insist on keeping the house unless you can afford it
You might feel emotionally compelled to keep your home in a divorce, but you should take a hard look at your finances to see if you can comfortably afford to carry the load on your own.
Not only will you need to buy out your partner and qualify for a refinance with your own financials and credit, but you’ll also need to shoulder the cost of maintenance and repairs moving forward.
San Diego-based family law and estate plan lawyer Michael C. McNeil urges his clients to think critically about finances and be conservative if they don’t have the funds to buy out their spouse.
“I usually counsel against taking out a larger loan to buy out the other spouse because incurring an even larger debt against a residence is often an unsound financial decision,” said McNeil. “This is especially so when the party buying the other out is also obligated to pay child and spousal support. Often, this has a severe impact on the buyer’s cash flow.”
If you’re the one leaving home, get your name off the mortgage
You might be the one leaving your marital home, but in the eyes of your mortgage lender, you’ll still be on the hook for payments.
In addition to buying out your portion of the home, your spouse will need to refinance and be able to qualify for the loan on their own. Refinancing will likely come with a higher mortgage payment and adjusted interest rate for your spouse, since he or she will need to solely shoulder the entire cost of the remaining mortgage, as well as the cash-out refinancing owed to you.
While you’re at it, check in on the health of your existing mortgage, especially if you plan to go on and buy another house moving forward..
“Well over 50% of the divorcing couples or divorced couples that I’ve worked for have missed payments on their mortgage,” says Ray. “Even if they miss payments, they have the expectation or the understanding they can still buy [their next] house. And that may not be the case.”
It might seem overly complicated or a hassle to ask your spouse to refinance, but if you don’t, you’ll still be liable in the case that your partner defaults on the mortgage or falls behind on payments.
To remove your liability entirely from the mortgage, your spouse will need to refinance as the sole holder of the loan.
Broker’s fee negotiations can get messy
If either party in your divorce is looking to make a buyout, make sure you have your bases covered in regards to future broker’s fees and agent commissions—typically 5-6% of the sale price of the home.
Sometimes the buying spouse will negotiate to have about half a standard broker’s fee taken out from the agreed value in the home. Typically, this is done because the buyer will end up paying these fees in the future when the property sells.
However, negotiating future broker’s fees is not legal in all states. Some states require that the home buyer in the couple pays all of the closing costs when the property is sold in the future.
If you’re considering a buyout, consult with an attorney or real estate agent regarding what’s possible around broker’s fees in your state.
If you or your spouse wants to sell your property soon, you should think twice about a buy out because you could end up paying for the fees out of your own share of the house rather than splitting it.
Think about the tax implications of your decision
Don’t forget to consider the tax implications of your various divorce settlement options.
The government allows married couples to exclude up to $500,000 of capital gains on their home sale while single filers can exclude up to $250,000. If you sell your house after getting divorced or remain married but change living situations, you could inadvertently increase your tax liability without proper planning.
That’s because you have to meet two criteria in order to qualify for the capital gains exclusion in a divorce:
- To pass the use test, the property has to be the principal residence of the seller for at least two of the past five years.
- To pass the ownership test, you must prove that you have owned your home for two of the last five years.
So say you sold your house in 2018 while you were still married to your spouse. You got divorced in Jan. 2019. To qualify for the $500,000 joint tax break, at least one spouse has to pass the ownership test, both have to pass the use test, and you have to file a joint 2018 tax return for the year the house was sold.
However, if you’d sold the house in 2018, but you actually moved out long before that and no longer meet the use test, then the person living in the house may only be able to exclude the single filer capital gains limit of $250,000.
When in doubt, consult a skilled CPA or real estate attorney to navigate the tricky world of taxes.
Know your state’s property division laws
What state you live in might impact the way you want to handle property in the divorce settlement.
If you live in a community property state, “all property of a married person is classified as either community property (owned jointly by both spouses) or the separate property of one spouse.”
So, anything you acquire while married is considered community property. Anything you came into the marriage owning, or acquire after the divorce is separate property. When you divorce, community property is divided equally among both parties.
On the other hand, in an equitable distribution state, assets and property acquired during a marriage are divided fairly, “but not necessarily equally.” That might mean that you own a percent of the total value, but not necessarily an even half.
How does this impact the sale of your property?
If you and your ex-spouse bought property together in a community property state, you own the property equally and the proceeds would be split 50-50. If one of you purchased the home before marriage, then that person would be the sole beneficiary of the sale.
Depending on how your settlement shakes out in an equitable distribution state, you or your ex-spouse might own a more substantial portion of your home due to income contributions or family involvement. That could mean it’s easier to buy out their portion of the property, or vice versa. Or it could mean more or less proceeds in your pocket from the sale.
Understand which division law is active in your state to weigh which course of action might work best for you.
What’s best for the family?
Working through such an emotional process can be personally draining, but you also need to consider what’s best for the family overall.
Depending on your relationship with your ex-spouse, you might try a setup called “birdnesting.”. Birdnesting is the practice of allowing your kids to stay in the marital home, while you and your ex-spouse rotate out. This arrangement can lessen the trauma for children going through a divorce, though psychologists only recommend it for a short-term transition.
Some ex-spouses also choose to occupy another unit on their property, or rent nearby while the other spouse stays in the familial home. It might be unconventional, but sometimes what’s best for the family isn’t the most straightforward solution.
Who gets what’s inside the house?
Deciding what to do with your home post-divorce is the first step, but what about everything in it? Unfortunately, you can’t cut your mattress or antique breakfront down the middle.
Worldwide legal provider ARAG offers a simple step by step to dividing up assets in the home:
- Create an inventory or list of your shared belongings.
- Agree to a specific value for each item. In this case, items of little to no monetary value don’t need to be included.
- With an inventory and the value of each item noted, you can go through the list and decide who takes what. If you aren’t confident tackling this task just the two of you, you might consider bringing in a mediator or your lawyers.
- Share your divisions with the court. In most cases, a judge will approve your decision if you can present a list of divided up property that you both agree on.
Consider creative avenues for property division
Just as no two relationships are alike, neither are two divorces. You don’t necessarily have to sell, buy out your spouse, or continue to hold the property. In some cases, you might decide to bargain using other assets.
Take, for example, a sizeable 401(k). In a recent case, Arizona-area attorney Timothy Durkin represented a woman who wanted to remain in her marital home post-divorce but didn’t have the funds available to buy out the husband’s portion of the property.
“After vigorous negotiation, we were able to keep the wife in her home by offering the husband the entire 401(k) account as an offset,” says Durkin. “The husband was happy as he got approximately $10k more in value than he would have received if he had to split the net proceeds from the home sale.”
There’s no one right way to divide your property when it comes to a divorce settlement, but with the right resources, assistance, and considerations, you can make the best decision for you.
Header Image Source: (Pawel Chu/ Unsplash)