Advisor Insight

Avoid these mistakes when divvying up assets in a divorce

Key Points
  • Even if two assets appear to have the same value, taxes can make one worth less than the other at the time of valuation.
  • The cost basis of any given asset is a key measurement and should be determined up front, experts say.
  • Even if you have an attorney and financial advisor advocating for you, it's important that you understand the implications of all money-related decisions being made.
Courtney Keating | E+ | Getty Images

Talk to anyone who's gone through divorce and they'd likely say the experience was no walk in the park.

Yet the notion may be weighing on more spouses during the pandemic, some research shows. For instance, based on Loanry.com's internal data, there's been a 62% increase in loan inquiries related to divorce expenses in the last 12 months, the company said.

However, that may not translate into a higher divorce rate in 2020, even if more people are exploring the idea.

"We all had predicted it, but we're not seeing it yet," said Elizabeth Lindsey, president of the American Academy of Matrimonial Lawyers.

"I think some people are waiting to see how long this [pandemic] is going to last," Lindsey said. "There may end up being some pent-up demand, so to speak."

If you happen to be in the midst of a divorce or are considering it, be aware that aside from its price tag — the median is $7,500, per legal website Nolo — there are other aspects of the process that can unexpectedly end up costing one spouse.

Ideally, you'll have an attorney and a financial advisor advocating for you. Regardless, experts say, it's crucial that you understand the implications of all money-related decisions.

"Take some deep breaths so you can really get to know your options," said certified financial planner Danielle Howard, principal at Wealth by Design in Basalt, Colorado.

"Once the ball starts rolling and all the emotional stuff is at the forefront, it can be challenging to deal with the financial side," said Howard, who is finalizing her own divorce after 28 years of marriage.

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Her biggest piece of advice?

"Do your homework," Howard said. "Find the right team to walk through the technical financial aspects, along with managing the emotional side. It will feel all-consuming, but you will get through it."

Here are a few common issues to be aware of.

Not all assets are equal

Some assets appear to have equal values. Yet once you factor in taxes, they may not look so identical.

"A hundred dollars in cash is different from [a stock] valued at $100," said CFP Lili Vasileff, president of Wealth Protection Management in Greenwich, Connecticut.

"Selling that stock has a tax impact," said Vasileff, who also is a certified divorce financial analyst.

Basically, the profit made on any given assets — the difference between the cost basis (generally, what you paid) and the sale price — ends up getting taxed as either a long-term or short-term capital gain once sold, depending on whether the asset was held for under or over a year.

A hundred dollars in cash is different from [a stock] valued at $100.
Lili Vasileff
President of Wealth Protection Management

"Even if two assets have the same value right now, the cost basis for them may be different, and one will have more or less taxes than the other," said CFP Sallie Mullins Thompson, principal of her eponymous firm in New York. 

"Subtract those taxes from the value if you're really going to do an equitable division," said Thompson, who also is a CPA and certified divorce financial analyst.

Similarly, if the asset in question is, say, a traditional 401(k) account, withdrawals will be taxed at ordinary income tax rates.

"I like for my clients to come up with a discount on the 401(k) because of the taxes on it when they take it out," Thompson said.

Retirement accounts

If you have a 401(k) or other workplace retirement account and your soon-to-be-ex is entitled to a piece, be careful how you arrange the split.

"I see some people take the money out of a 401(k) and then give it to the spouse," Thompson said. "If they do that, there will be a 20% tax withholding."

Additionally, if the account holder is younger than age 59½, a 10% penalty for early withdrawal could apply.

Instead, you need an attorney to draft what's called a qualified domestic relations order, or QDRO. This is separate from the divorce agreement, although it is based on the contents of that decree. It, too, gets approved by the court and sent to your 401(k) plan administrator (which also must okay it). And if more than one workplace account is getting split, a separate order is required for each one.

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There are a couple ways your ex can get their share of the 401(k), both of which must be spelled out in the QDRO. The first is via a trustee-to-trustee transfer to a rollover IRA, which is not a taxable event for either of you.

Alternatively, some ex-spouses choose to have the QDRO specify that they should receive 401(k) funds directly from the plan. If this route is chosen, the recipient would pay no 10% early-withdrawal penalty, but ordinary income taxes would be due on any amount that does not get contributed to a rollover IRA within 60 days.

Meanwhile, while splitting an IRA does not require a QDRO, you still must do a trustee-to-trustee transfer, with the funds put in a rollover account for the recipient, Thompson said.

Additionally, make sure that if the intent is for each spouse to get, say, 50% of a retirement account's assets, the divorce decree (and QDRO) state that percentage instead of a dollar amount.

Here's why: Say $100,000 is in a 401(k) and the non-account-owner is to receive 50%. If the QDRO states the receiving spouse should get $50,000 — which represented 50% at the time the order was written — and the account posts gains or losses before the transfer is made, $50,000 no longer represents 50%.

The family house

Sometimes, divorcing couples sell the family home and divide the proceeds as dictated in their agreement.

Other times, one of the spouses remains in the house. In this situation, depending on the specifics, there are a few things to watch for.

For starters, assuming your ex will no longer be a joint owner or responsible for any mortgage on the home, you would need to refinance the loan and qualify for it on your own.

However, at the time of valuing the property during divorce discussions, be sure to get an appraisal — as well as determine the cost basis of the property. Once it is in your name only, and you go to sell it at some point, you alone will be responsible for paying capital gains taxes on any profit that exceeds the current exclusion of $250,000 per person.

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"If you had sold it while it was in joint names, you'd get the higher exclusion [for married couples] of $500,000," said Vasileff, of Wealth Protection Management.

There are some other tricky situations that could result in a bigger capital gain than anticipated.

For instance, if you and your spouse bought your current house before 1997 when tax laws were different, there's a chance deferred gains from another home sale were rolled into the purchase, Thompson said. 

If so, the cost basis of the property being evaluated in divorce needs to be reduced by the deferred amount, she said. That generally will result in a bigger profit when sold.

Another tricky situation: If the departing spouse used a home office, which resulted in the home's depreciation over that time (for tax purposes), the cost basis must be lowered to reflect that amount. Again, that generally would result in a larger gain upon the property's sale.