You should value each asset based not on its fair market value but on how much cash you would have in your hands after paying federal, state and local income taxes if the asset was disposed of on the day after the divorce is finalized. Marital assets could include, among other things, cash, personal property, pension accounts, stocks and bonds, collectibles, a personal residence and a vacation or rental property. The disposition of each item may be treated differently for tax purposes.
· Cash, and cash-equivalents like a money market account, is worth what it is worth. Its cost basis and its fair market value are the same. There is no tax consequence on the disposition of cash.
· Personal property – furniture, a car, etc - generally decreases in value over time. As you cannot deduct the loss on the sale of personal property there is generally no tax consequence to the disposition of personal property. However, any gain on the sale of personal property is taxable (see below regarding appreciated assets).
· The tax treatment of pension distributions depends on the type of account and the source of the contributions to the account. Distributions from a 401(k) or 403(b) or 457 plan are generally fully taxable as ordinary income, as contributions are usually made “pre-tax”. Qualified distributions from a ROTH IRA are totally tax free. However an IRA funded by individual contributions may have a “tax basis” depending on whether the contributions to the account were deductible or non-deductible. An IRA account, or an employer pension account partially funded by “after-tax” contributions, that has a “tax basis” is slightly more valuable than one from which distributions will be fully taxable.
· Stocks and bonds are “capital assets” and are taxed upon disposition based on the holding period of the individual investment.
· Gain on the sale of collectibles (work of art, rug, antique, precious metal, gem, stamp, coin, or alcoholic beverage held more than 1 year) is taxed like stocks and bonds, or any other appreciated asset, although at possibly a higher tax rate.
· An individual can exclude from taxable income up to $250,000 of gain on the sale of a personal residence, as long as he/she owned and lived in the residence for 24 months during the 5-year period prior to its sale. So there may be no tax consequence on the disposition of a personal residence. On the other hand, a vacation or rental property is taxed as a “capital asset”, like stocks and bonds. In the case of a rental property, any depreciation claimed over the years must be “recaptured”.
The disposition of certain marital assets may be taxed differently on the state and local return than they are for federal tax purposes – so you should be sure to take the state and local tax consequences into consideration as well.
Let us look at a simple example:
A divorcing couple with assets valued at $550,000 decides on an equal split. Their cash balance of $50,000 will be split evenly. The wife will take full title to their personal residence valued at $250,000, which they owned and lived in for the past 30 years, and the husband will receive an investment portfolio of appreciated stocks worth $250,000. All of the stocks in the portfolio had been held for more than one year and the cost basis is $150,000. There is no mortgage or equity borrowing on the personal residence.
If the wife sells the personal residence there will be no federal or state tax on the gain. However, if the husband liquidates the investment portfolio he will pay 15% federal and let’s say 5% state income tax on the $100,000 taxable gain, a total of $20,000. So the “after tax” value of the portfolio is only $230,000. For the split of assets to be truly equal the husband should get $35,000 of the cash and the wife only $15,000. Each spouse then walks away with $235,000 “after taxes”.
to be continued. . . . .