To Liquidate or Not…That is the Question

On behalf of The Marks Law Firm, L.L.C. posted in Divorce, Legal Separation, Maintenance, Marital Property, Property Division, and Retirement Accounts on Tuesday, June 17, 2014

In Missouri, as in most states, asset division in divorce begins with the goal of “equitable” distribution, which often translates into 50-50 shares of the marital pie.  But not all divisions are equal, principally because of the financial consequences of splitting certain assets and the different financial positions of the parties.

For many families, the principal asset is the marital home.  Particularly if the couple has children, each party will want to keep the marital home to maintain a sense of consistency.  However, for one party to assume sole ownership, that party often will have to refinance the mortgage.  Some spouses will lack the ability to refinance, either through lack of sufficient employment or collateral.  Other spouses will lack the ability to afford the refinance, given that interest rates are higher today than when many individuals purchased their homes.  As a result, the “win” of receiving the house turns into a terrible burden.

What happens if a party cannot secure a refinance or afford sole ownership?  That party must sell the house, often in a hurry.  If the party sells the house for a profit, that party will owe capital gains taxes, which will reduce the net equity by at least 25%.  Also, that party may have to pay certain sums to fix up the house for sale.  For parties unprepared for the sudden transition from homeowner to quick seller, they could see dire results, including forfeiture, credit problems and more.

Consider another large asset – retirement or pension accounts.  The purpose of a retirement or pension fund is to save up for when you stop working.  Our tax system encourages saving by not taxing contributions to an IRA and in fact giving a tax break on the first $5,000 contribution annually.  Because these assets are future oriented, they penalize early withdrawal.  While most allow a party to borrow against the fund at a low interest rate if paid back within a certain time, all will heavily penalize a contributor who cashes in early – often a fixed penalty plus the burden of paying income and/or capital gains taxes.  Most people who go the early withdrawal route do not realize that the cost of doing so will mean a loss of 35-50% of the net value.

Given that liquidation carries some heavy consequences, parties should seek to avoid liquidation wherever possible as they divide assets.  Parties can act creatively and determine the optimal way to divide the marital assets to minimize tax and penalties.  Courts tend not to do so, mainly because the job of the court is to divide assets equally, not optimally.  So, when a party cannot retain the marital home, the court will order it sold, resulting in losses to both parties in terms of net equity due to taxes, real estate sales costs and repairs.  Courts can divide pension and retirement accounts with a softer touch through a qualified domestic relations order (QDRO) that facilitates a tax-free transfer of a portion of the fund to the former spouse – but if the spouse has a present need for cash, that transfer will not end up tax free.

The lesson of liquidation is simple:  parties will better secure for themselves a greater net share of the marital assets if they work together to divide them outside of court, perhaps with the assistance of an accountant or experienced attorney with full knowledge of the tax implications of different marital divisions.  Given that half does not always mean half, it is in both parties’ best interests to negotiate a division that protects as much of the marital estate as possible, while also addressing current and future financial needs of both parties.  For example, one spouse might choose to trade a lesser amount of a retirement account for short term maintenance – a trade that would benefit both parties and perhaps not even reduce the actual marital estate after considering the tax implications of maintenance.  This type of proactive thinking usually leads to the best financial outcome in dividing marital assets.

If you have questions about asset liquidation in marital property division, contact our St. Louis family law attorneys – we can help.

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