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Tax planning and divorce

Thursday, February 22, 2018

Almost half of all American marriages end in divorce. But like most other life-altering events, there are still tax consequences. Financial planning for the tax consequences associated with property division should take place well before the decree is issued.

A spouse should address the designation of beneficiaries or the person who receives their money after death from a 401(k), pension plan or other qualified retirement plan. Normally, the spouse was named as a beneficiary many years ago after a very short time of reflection.

After divorce, a spouse may want most any other person to receive this. However, the person designated as beneficiary overrides any other person named in a will or other legal document. In other words, a former spouse designated as a beneficiary could receive this money instead of a current spouse or the children under federal law.

Next, divorce can erase any capital gains tax advantage associated with the sale of a house. The exclusion is $250,000 for an individual or $500,000 for the couple.

If a house was purchased for $200,000 and is sold for $1 million, there is capital gains tax for the $800,000 difference between the sale and purchase prices. If the couple is married at the time of sale, they are eligible for the $500,000 tax exclusion instead of the $250,000 exclusion for one former spouse.

Selling the house after divorce is identified as a $550,000 taxable profit taxable at 20 percent for capital gains which has a tax liability of $110,000. However, selling the house before divorce excludes the first $700,000 comprised of the $200,000 purchase price and the $500,000 exclusion for the couple. This leaves a tax liability of only $60,000.

The couple had to live in the house for two of the five years before the sale. There may be an additional three years allowed for the couple even if they do not live in the house if they are not divorced.

If one spouse keeps the house, an equal division is unwise because of the property's tax liability if the house increased in value. Taxes cover the entire sale price of the house which may be higher than its value when it was divided.

An attorney can help deal with these divorce legal issues. A lawyer may also assure that a spouse can pursue reasonable options following the end of a marriage.

Source: San-Antonio Express News, "Tax strategies in divorce," By Michael Taylor, Aug. 21, 2017

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