Family Home Division
In many family law cases, the biggest financial challenge is the family home division. Most often, the question is who gets the family home in divorce. Should the wife get it, should the husband, or should they sell it and split the proceeds? And if they sell it how should the proceeds be divided. A family home division may require considerations for maintaining the stability of children and the ability of a spouse to relocate.
Many times, the wife has an emotional tie to the home and she wants to keep it. This is where she raised their children and decorated and entertained. But she needs to consider whether she can afford to keep the home. If she keeps the house she is getting an illiquid asset that does not buy groceries for her children or create any income.
Ownership
A family home division requires that the property be characterized to determine who owns the house. Is it entirely community property that should be split equally? Does one spouse have a claim to a greater share? Did one spouse own the home before marriage?
In California, there is a presumption that property acquired during the marriage is community property and each spouse is entitled to an equal share upon divorce. However, in the case of the family home this presumption may not apply if title is not in joint names. For example, if a house is purchased during the marriage but only one spouse’s name is on the title that spouse may be able to claim that the entire property is their separate property and that they do not have to share it with the other spouse. This can lead to very unfair results if the mortgage was paid during the marriage with community earnings or the down payment was made with community savings. To avoid this result the disadvantaged spouse has to prove that there was a breach of a fiduciary duty and the Court should treat the house as community. If you are ever in this situation you need to immediately consult with an experienced family lawyer. Further, if your credit is bad and your spouse ever tries to convince you that the only way to get a mortgage is to put title in their name you should immediately consult with an attorney.
Home Purchased Before Marriage
The date of purchase will affect the family home division. Often, one spouse owns a house prior to marriage. During the marriage the title remains in that spouse’s name but the outstanding mortgage is paid with community earnings. The spouse who is not on title may still have a community property interest by virtue of the mortgage payments made with community earnings. This is commonly referred to as a “Moore-Marsden” interest based on the two cases that establish the formula for calculating the community interest. When a couple have been married a long time and substantial amounts of community earnings have paid off an existing mortgage, making improvements or the parties have re-financed, this “Moore-Marsden” interest can be substantial. You may wonder why this situation is so different to the one above where the home is acquired during the marriage in one spouse’s name. The simple answer is that’s what the Courts have decided. If you are ever in this situation you need to immediately consult with an experienced family lawyer.
Options for Division
Once you determine who gets the family home in divorce, you then have to decide how the community interest is divided – this is the family home division formula. There are three options if you are trying to reach a settlement:
- One spouse buys out the community interest share of the other spouse;
- The house is sold and the proceeds are divided; and,
- The house remains in joint names for a limited period of time and is then sold to the other spouse or is put on the market.
During economic downturns when house prices are depressed couples increasingly turn to the last option. But there is a catch. If you litigate, option (c) is called a deferred sale order (or a “Duke Order”) and the Court can only order a deferred sale in very limited circumstances where it is in lieu of child support and economically feasible.
Division Upon Sale
If the home is only asset of value in the marriage, the house may have to be sold unless one spouse is able to raise sufficient funds to buy out the other. Otherwise there are several ways to buy out a spouse’s interest in the family home.
- One party may be able to buy the other out if they can re-finance and qualify for a new mortgage on their own using their own income. The selling spouse should never agree to remain on the mortgage.
- If refinancing does not generate sufficient income, the selling spouse may be persuaded to accept an installment note secured by a deed of trust on the home. This is generally a bad idea. A spouse who cannot afford an immediate buy out upon divorce, in the long run is probably not going to pay all the costs associated with maintaining a home and pay back the installment loan.
- Another option is buying out all or some of the community interest in the house with a release of spousal support. You will need to consult with an attorney and a tax specialist to determine the present and after tax value of the total support payments that are being exchanged.
- It may also be possible to borrow from a retirement plan to finance the buyout. Again you should consult with a pension and tax specialist to discuss the costs of borrowing from your retirement plan. You may have to pay income taxes on the withdrawal and 10% early withdrawal penalties. You should also find out whether such a loan qualifies for mortgage interest deduction on your taxes.
- If there are other assets in the marriage, one spouse may elect to keep the house and the other may keep assets of equal value. For example, if the equity in the house is $200,000 and the value of pensions is $200,000 one spouse may keep the house and the other may keep the pensions. This is discussed in more detail below.
Affordability
It is very important to consider the financial as well as the legal realities of electing to keep the house. It is used to be very common where the husband owns a business to suggest that the wife keeps the house and the husband keeps the business. Before even getting into whether this is a fair exchange of assets of equal value, one has to consider whether the spouse who wants to keep the house can afford to do so. Often the spouse who has primary custody of children wants to stay in the house for the sake of the children but this may not be economically possible. The spouse who wants to stay in the home should sit down and work out a budget. They should estimate housing costs and compare this with their estimate earnings from employment, support and other sources. Housing costs are more than just mortgage and property taxes and one should factor in utilities, repairs, insurance, fees etc. You may also be entitled to mortgage interest deduction relief lowering your costs. If you can still afford to stay in the house, only then should you consider this option.
Home Value
If you decide to either to buy out the other spouse’s community interest in the house or to exchange it for another asset, you will need to know the equity and financial value of the house. The equity in the house is equal to the house’s fair market value less any debts connected to the house such as mortgages and liens. The fair market value of the house is usually assessed by a certified real estate appraiser. The parties may agree to jointly retain an appraiser to keep down costs. A certified appraiser who knows the local market may provide a more accurate appraisal than the local realtor. Sometimes couples place the house on the market to see of anyone makes any offers.
It is important to note that if the Court is asked to calculate each spouse’s share in the house it will only consider the equity value. The court will not consider other costs that might reduce future sale proceeds such as closing costs, sales commissions and tax bills because those costs are not considered “immediate and specific.” Therefore, if the fair market value of the house is $500,000 and the balance of all outstanding mortgages is $200,000, the equity value of the house is $300,000. If this is all community interest then each spouse will be entitled to $150,000.
If you are trying to negotiate a settlement, you may wish to argue that the financial value of the house should be considered after taking into account taxes after sale and closing costs. This is important because once you get divorced and awarded the house you are only entitled to a $250,000 exemption on any gain. Therefore what may look like a fair bargain may not seem so fair after you factor in taxes.
Consider this example: the equity value of the family home is $500,000 and the equity value of stocks and shares is also $500,000. Is this a fair exchange if the husband keeps the stocks and shares in exchange for the house? It depends. Assume that the shares have a high tax basis so that if they are sold the husband is liable for $100,000 of gain. The wife on the other hand is liable for $250,000 gain if she ever decides to sell the house. Is this still a fair exchange?
Title is Held in Joint Names
When the house market is depressed, spouses may want to hold onto the property in joint names until house prices rise again. Most couples will want to hold the property as tenants in common. You will want to retain an experienced family law attorney in this situation since there are considerable risks for both parties. Any agreement should clearly specify who is responsible for housing costs such as mortgage payments, insurance, property taxes and maintenance and repairs. An agreement should also specify how risk will be allocated in the event of damage or loss and how adequate insurance coverage will be maintained. The parties will also have to agree on the time-table for selling the house. Sometimes it is linked to the children’s ages and completion of school. It may be linked to a limited time period – say two to three years – based on speculation as to when house prices will rise. Once the time period expires, the house will either be placed for sale on the market or the parties have the option of buying out the other at an agreed upon formula.
Family Home Division Deductions
The home mortgage interest deduction should be taken into account when you consider whether or not you can afford to stay in the house or whether it will be available if you decide to maintain joint ownership of the house after the divorce. You should review IRS publication 936 “Home Mortgage Interest Deductions.” You can deduct home mortgage interest if all the following conditions are met:
- You file Form 1040 and itemize deductions on Schedule A (Form 1040).
- You are legally liable for the loan.
- There is a true debtor-creditor relationship between you and the lender.
- The mortgage is a secured debt on a qualified home in which you have an ownership interest.
If you keep the house in joint names, the spouse who does not live in the house may also be entitled to take a spousal support deduction for payments that are made directly to the bank for mortgage and property tax payments.
Capital Gains Tax Exclusion
Under IRS §121, the gain on the sale of a principal residence is excluded up to $250,000 for a single person and $500,000 for a couple filing a joint return. A detailed explanation of IRS §121 is set forth in IRS Publication 523, “Selling Your Home.” To qualify for the exclusion that taxpayer must have owned and used the residence as a principal residence for a total of at least 2 years in the 5 years immediately ending on the date of sale or exchange. If one spouse receives the family home as part of the divorce settlement, that spouse will only be entitled to a $250,000 IRS §121 exemption when they sell it. If a couple decides to keep the family home in joint names as part of a divorce settlement and to sell it later, both former spouses may be entitled to the $250,000 IRS §121 exemption, if one of the spouses continues to live in the home as their primary residence. For example, husband and wife divorce in 2000 and as part of a marital settlement agreement or stipulated Judgment agree to allow wife to say in the home for another five years when the children are 16. If the house is then sold at a gain of $700,000 both husband and wife can exclude $250,000 of their $350,000 gain on the sale.
Occupancy by One Spouse
It’s often the case that after separation one spouse moves out of the family home (“the out-spouse”) while the other spouse stays in the home with the children (“the in-spouse”). This will affect the family home division. The out-spouse, usually the husband, may offer to maintain the status quo by continuing to pay the mortgage payments and other payments such as property taxes to maintain the property. In such a situation the in-spouse should be warned that there may be serious consequences of such an arrangement at the time of trial.
One consequence is that the out-spouse paying the mortgage payments may be entitled to what are called “Epstein” credits because they are paying separate property earnings towards a community property debt unless there was an agreement to waive such reimbursements or such payments were a form of child or spousal support.
The other major consequence is that if the reasonable rental value of the family home is more than the mortgage payments, the in-spouse may be required to reimburse the community for the difference in these payments between the date of separation and the date of trial. These are called Watt’s charges after the case that established the rule. The general rule is that where one spouse has the exclusive use of community assets during the date of separation and trial, that spouse may be required to compensate the community for the reasonable value of that use. Consider this example. Husband and Wife separate. Wife and the kids stay in the family home after separation. Husband agrees that he’ll continue to support the family and pay the mortgage and other expenses. The mortgage payments are $1,500 per month. If Wife had to pay the fair market rent for the property she’d pay $2,500 per month. Husband pays the mortgage for 10 months from the date of separation to the date of trial. Husband could argue that he should be reimbursed Watt’s charges of $10,000 ($2,500 – $1,500 x 10). In a division of community property he’d be entitled to an extra $5,000.
Husband could argue that he should also be entitled to Epstein credits of a further $15,000 ($1,500 x 10) which would increase his share of community property by $7,500. This would mean that Wife’s entitlement to community property would be reduced by $25,000 when she thought that Husband was supporting her and maintaining the status quo? Isn’t this grossly unfair? You’d think so but that didn’t stop the Court of Appeal awarding Epstein credits and Watts charges in similar circumstances in In re Marriage of Jeffries (1991) 228 Cal. App. 3d 548. But wait a minute. Isn’t there an exception to the rule where payments are made “in lieu of spousal support?” The answer is yes “but” this has to be clearly spelled out before the Court will treat such payments as support. In Jeffries, there was even an Order of the Court that said the payments were “in lieu of spousal support.” However, the Order also said that the Court retained jurisdiction to characterize these payments and determine whether the Husband should be entitled to reimbursements.
In another case the Court of Appeal reached exactly the opposite conclusion to Jeffries. In that case the husband also paid the mortgage pursuant to a temporary court Order “in lieu of spousal support” and at trial claimed Epstein credits and Watts charges. The Court of Appeal held that public policy and the language of the Court order required that the Court deny the husband’s claims for Epstein credits. The Court then decided that since the wife was, in effect, paying the mortgage she would not have to pay any Watt’s charges because the monthly mortgage payments were the same as the fair market rental value of the home.
The only solution to this mess is for the parties and their attorneys to agree early on in the proceedings whether a spouse’s payment of community debts (such as the mortgage) and one spouse living in the family residence should be treated as spousal support which does not generate Epstein credits or Watt’s charges. If it’s treated as spousal support any agreement or Order should contain explicit language that mortgage and other payments by the out-spouse and exclusive residence by the in-spouse in the family home “shall be treated” as spousal and child support and the paying spouse shall not receive any reimbursements such as Watt’s, Epstein, Jeffries credits and charges.
For more information on the Family Home Division and California Community Property, click on one of the following links:
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