Why Aren’t all Assets Equal in Equitable Division?

Should you retain me to handle your divorce and should equitable distribution of your assets and debts be an issue, at some point I will create an equitable distribution spreadsheet.  In this spreadsheet we will list all the marital assets and debts being divided, value each item, and apportion that valuation between you and your spouse.  We can then develop equitable distribution scenarios and see what percentage of the total net worth each spouse retains under a particular scenario.

In developing equitable distribution proposals it is vital to understand that not all dollars are created equal.  Many litigants and even some of my clients have failed or refused to understand this, and this lack of understanding has been to their long term detriment.

Cash, which includes for this analysis savings, checking and money market accounts, is the “gold standard” of equitable distribution.  A dollar of cash is worth a dollar and, all other things being equal, I advise my clients to try to keep as much cash as possible, or pay as little cash as necessary, as part of any equitable distribution proposal.  The great things about cash: it’s tax free; you can spend it anywhere; and there are no transaction fees when you turn cash into goods or services.  To misquote The Godfather: Leave the cannolli; take the cash.

Stocks and bonds are almost as liquid as cash but, unless they have not increased in value since purchase or inheritance, are subject to capital gains taxes.  The current capital gains tax rate is low (relative to the tax rates on income) but this has not always been the case.  On the other hand, a stock or bond that has decreased in value comes with a potential capital loss than can, to a limited extent, be balanced against income to reduce state and federal tax burdens.  Investments subject to capital losses may actually be more valuable than the equivalent amount of cash.

Unless one will be paying off debts immediately, the interest rate on debt should be considered in equitable division.  If two credit cards carry a balance of $10,000 but one has a 6% interest rate and the other has a 19% interest rate, the credit card debt at 6% interest is vastly preferable.  Paying $100.00 per month will pay off the 6% card in138 months but will never pay off the 19% card.  Raising the monthly payment to $200.00 per month pays off the 6% card in 58 months but pays off the 19% card in 100 months.  When interest rates are near the rate of inflation (as is sometimes the case with car loans) interest on debt isn’t a big factor.  Otherwise the expected interest expenses in paying off debt needs to be factored into equitable distribution proposals.

You may have just bought a beautiful sofa for a few thousand dollars but, if you need to resell it, you might be lucky to get half that amount for it on craigslist.  Even items for which there is an organized market for used goods, such as guns or jewelry, have a significant gap between retail price and resale price. Especially for goods that will likely be sold in the near future, using a retail valuation will significantly overstate the actual value for the purpose an equitable division of assets.  For equitable division, household items should be valued a current resale value.

There are tax, transaction costs, and cash flow issues that impact the equitable distribution of the marital home.  A dollar of home equity does not equal a dollar of cash.

Currently when you sell your primary residence, you can make up to $250,000 in profit if you’re a single owner, twice that if you’re married, and not owe any capital gains taxes.  However, the tax laws on the treatment of capital gains from the sale of a primary residence, and even what constitutes a primary residence, change so frequently that it makes sense to consult an accountant when considering the equitable distribution of any home with significant equity (in the current housing crash this is becoming less of an issue).

If you intend to sell the marital home as part of an equitable distribution award, the real estate sales commission is a transaction cost that needs to be factored into valuation.  If you intend to remain in the house and that house has a mortgage, the interest rate issues discussed in the section on debt above come into play.  Further, the cash flow needed to pay the mortgage, taxes, insurance, and maintenance need to be compared to the rental cost of a similar home (or a more modest home if the marital home is more “house” than one needs or desires after the divorce).  Many a divorcing spouse who fought to keep the marital home has later regretted that choice when he or she realized their primary asset was consuming too much of their cash flow.   However, even in a market in which real estate values remain flat, a primary residence can be a useful asset, especially when a significant portion of the monthly expense goes to principal. In that circumstance the home expense can be a method of forced savings.

Investment real estate–whether second homes, investment homes, or commercial real estate–has less favorable tax treatment than that for the primary residence.  One needs to know the tax basis for these properties because, upon sale, any value above the basis will be subject to capital gains taxes.  If two investment properties are worth $100,000 but one has a tax basis of $100,000 and one has a tax basis of $50,000, no capital gains taxes will be due upon the sale of the first property but taxes on $50,000 of capital gains will be due upon the sale of the second property.  For equitable distribution purposes, these homes are not equivalent.

Cash flow issues also become more important for such real estate.  The contrast between two pieces of real estate with similar equity, one with a stable tenant providing positive cash flow and the other with unstable or negative cash flow, is not a comparison of equals.  Treating such situations as equal in any equitable distribution proposal is mistaken.  Further, any anticipated sale of such real estate should anticipate the commission costs involved.

A dollar of a typical IRA or 401(k) is not worth a dollar of cash.  In certain circumstances, they might only be worth half of their face value.

There are two reasons such retirement accounts should be discounted in equitable distribution: early withdrawal penalties and taxes.  With certain limited exceptions, one cannot withdraw from an IRA or 401(k) until one is 59 ½ years old without paying a 10% income tax penalty.  One of the exceptions is that, as part of a divorce, a spouse can take out 401(k) money he or she has been awarded without paying the 10% penalty.  Further, one pays state and federal income taxes on such withdrawals.  Currently at age 70 ½ one must start withdrawing from these retirement accounts, and one will have to pay these taxes upon withdrawal.

The higher one’s tax bracket (or expected tax bracket when expecting to withdraw from these retirement accounts) and the younger one is the greater the discounting a dollar of retirement accounts entails.  Such discounting needs to be factored into an equitable distribution analysis.

A Roth IRA is not subject to tax and penalty concerns and does not need to be discounted for any equitable distribution award.

Cash, generally, is king.  Every other asset has tax, cash flow or transaction cost issues that make them less valuable.  A client who receives nothing but cash in equitable distribution and saddles the other spouse with debts and other less liquid assets should not expect to receive 50% of the net equity in the marital estate as part of any “equitable” distribution of the marital estate.  A client who is willing to provide the other spouse nothing but cash as part of equitable distribution should expect to receive a greater share of equitable distribution for this generosity.