Whenever possible, assets and debts should be divided on an after-tax basis. Consider the following example:
Jack and Jill are in their mid-fifties and have been married for 30 years. Their children are grown and they are still living in the marital residence they purchased 25 years ago for $150,000. They have decided to divorce and are trying to amicably divide their assets. Jill would like to keep the marital home as this is where she raised her family. Jack would like to retain his 401k plan as he worked very hard at his company. They also have an investment property that they purchased 15 years ago which Jack thought he could live in for a year before selling it. Jack and Jill also had some stock, cash and CDs.
They agreed to divide these assets in the following manner: They both thought this sounded fair, but they forgot to take into account the tax ramifications of selling the assets. After meeting with a divorce tax planner, they revealed the following details:
1. The marital residence was purchased 25 years ago for $150,000 and $50,000 was spent on an addition 15 years ago. Although the house was valued at $400,000, there was no mortgage on the property and the capital gain upon sale would be $200,000 ($400,000 minus $150,000 purchase price minus $50,000 improvements). This is less than the $250,000 Section 121 allowance on sale of personal residence, so no tax would be due upon sale.
2. The investment property was purchased 15 years ago for $100,000. It has $50,000 of depreciation which needs to been recaptured and taxed upon sale, as well as, tax on the capital gain of $150,000.
3. Jack will need to pay ordinary income taxes on the 401k distributions upon retirement.
4. Jack will have a $50,000 capital gain upon the sale of his stock.
A more accurate after tax value revealed the following information: