The house is one of the most important assets in most divorces. It can have a large monetary value as well as a large debt. Moreover, it is shelter for the family. And people have a lot of historical and emotional attachment to their homes. I thought the various issues involving the house might best be addressed in this short play.

Act One: The Wife’s Lawyer

Venerable divorce lawyer Simon Nicholas enters from stage left to start his day at his well-appointed law office, which takes up half the stage. There are freshly pointed pencils, tips upward, in a cup on his desk. He sits down at his large desk, which has only one piece of paper in the center. He picks up one of the pencils and starts to write, when the phone rings. He answers gruffly with only his last name. The other half of the stage is then lighted to show the caller, a woman named Brooke Davis, in a French-style kitchen tastefully decorated in reds, blues, yellows, and golds. Clerks continue to come in and out of Simon’s office with papers, which he signs without reading while talking on the phone.

BROOKE: Mr. Nicholas, this is Brooke Davis. Remember, we talked the other day about me hiring you for my divorce.

SIMON: Of course. How are you today, Brooke?

BROOKE: Better than when we last talked. But I woke up last night in a cold sweat: We never talked about the house. What do we do about it?

SIMON: You are right that the house is usually the first thing to be dealt with in a divorce. It is typically one of the largest assets in the marital estate. If there is other real estate, like a rental property or vacation home, you’ll have to decide what to do with those as well.

BROOKE: There is no other real estate. But we worked hard and saved and sacrificed to own our own home.

SIMON: It’s the American dream.

BROOKE: I love this house. Our children were born and raised here. So many memories. Some good. Some bad.

SIMON: The house is especially hard to deal with because besides being an asset, it is shelter for the family, with emotional attachments and memories.

BROOKE: Plus, I don’t have the energy it would take to find a new place to live in, to pack, and to move, all in the middle of a divorce. I just can’t deal with this.

SIMON: But deal with it you must. You and your husband need to decide who is going to live where, and what timesharing arrangements will be made for the children.

BROOKE: I want to keep the house, if I can, for the children’s sake. But my husband says we can’t afford to. We have to sell it and split the proceeds.

SIMON:Many financial experts say you should not try to hang on to the house. It’s not a liquid asset. You can’t feed your family on the equity in your house. But some people do keep the house in a divorce. And over time, it has paid off in appreciation. You’ll have to make a budget and take a look at your finances to see if you can afford the mortgage, utilities, and upkeep for the house. We’ll have to estimate some items, such as alimony and child support, and your future earnings and child care expenses. Some people are able to rent out a room in order to help with expenses.

BROOKE: Will we have to sell the house?

SIMON: That depends. These are the issues that must be negotiated and decided by the parties if possible. Otherwise, a judge will have to decide them for you. Then you will have less flexibility. For example, it is not uncommon for a judge to order the marital residence to be sold by a trustee and the proceeds to be divided equally. If you negotiate your own settlement, one spouse may be able to buy the other out and keep the house in exchange for cash or some other marital asset. If you do agree to sell it, we can ask for a right of first refusal, giving you the right to buy the house at the same price as any contract for sale you accept.

BROOKE: I want him to move out.

SIMON: Then, ask him. But if your house is in joint names, or titled as tenancy by the entireties, which is joint title by a husband and wife, you may not be able to get your spouse to move out. Ownership of property gives the owner the legal right to occupy the premises. Your spouse can move voluntarily, but he cannot be forced to leave unless he commits domestic violence. This can be a vexing situation, especially if you need separation as grounds for divorce.

BROOKE: What if he agrees to move out?

SIMON: Even when a spouse moves out, he has the right to reenter the house at will. In order to give each party privacy, and prevent claims of abandonment or desertion, the parties may enter into a move-out agreement that sets forth the mutual and voluntary nature of their separation as well as the terms for the payment of expenses and the timesharing arrangements for the children.

BROOKE: Can I change the locks?

SIMON: In the absence of an agreement, it is not a good idea to change the locks. Since he is also an owner of the house, he can call a locksmith or break a window. And this could work against you in your divorce. It could possibly cut off your spouse’s responsibilities to contribute to the costs of the house. We can talk more about it when you come in. Are you looking at your calendar? How does Friday at 2:00 p.m. sound?

Act Two: The Husband’s Lawyer

The scene is Marvin Scott’s law office, which has a cheap desk, pictures askew, and papers strewn about in stacks. Ric Davis, Brook’s husband, sits across the desk from Marvin in one of the torn leather and chrome client chairs.

RIC: I just want to make sure I’m not living in my car when this is all over.

MARVIN: You won’t be living in your car. Did you purchase the house after you were married?

RIC: Yes. Why?

MARVIN: If you owned the house before the marriage and never changed it to joint ownership, it is premarital property. However, your wife might still have a claim to a marital portion of the appreciation on the house, based on mortgage payments and repairs made with marital funds during the marriage.

RIC: We bought it after we were married.

MARVIN: I’ll need to see a copy of your deed. Most marital residences are held jointly. Joint ownership by a husband and wife is called a tenancy by the entireties. However, sometimes a house is bought during the marriage but put in one spouse’s name only. It is still marital or community property if acquired during the marriage or put in joint names during the marriage. If you used separate property to acquire the house, you may be entitled to a credit for that contribution.

RIC: That was a long time ago. But I am pretty sure I put down $30,000 from the sale of my bachelor condo.

MARVIN: Let me tell you what proof will be required in court, and probably in settlement negotiations, if your wife’s lawyer is on the ball. Proof consists of canceled checks, bank statements, and settlement forms, like HUD-1. You will need to show that the money came from your condo sale, went into your bank account, did not go through a joint account, which hopefully it didn’t, and finally that it was used to purchase the marital residence. This can get even more complicated to trace if there are other sales or refinances.

RIC: Ok, let’s say I can find the proof. Do I get my $30,000 back and then we split the rest?

MARVIN: There are several ways to calculate it. Some states do not permit any tracing at all. The majority do. The parties may agree on any division that they think is fair and the court will approve it. One simple way is to return each party’s separate contribution plus interest at a fair investment rate. Or, if you want to get more sophisticated, you could use the percentage rate at which the house appreciated during the period you owned it.

RIC: How would the court calculate it?

MARVIN: We use what is called the Brandenburg Formula in this state. It is explained in a case by that name, and several states use it. This formula uses contributions made at the purchase of the house to determine the percentages of the sale’s proceeds. So, if you bought the house for $100,000 and you each paid $30,000 from your separate assets, then your separate share is 30 percent of the proceeds. The other 70 percent is marital property and is divided equally.

RIC: She wants me to move out, but I can’t afford to keep paying for the mortgage and rent a place to live. We need to sell the house, get the cash, and get out from under the mortgage payments.

MARVIN: You are not required to move out. You have all the rights of ownership. Just tell her you’re not moving until you reach a settlement.

RIC: Can I list the house as for sale now?

MARVIN: You will need her agreement and signature on the listing agreement. She will also have to sign the deed when you sell the house.

RIC: What happens if we cannot agree?

MARVIN: In our state, the judge can transfer the title of the house to one or the other parties. But it is more likely that the judge will order it to be sold by a trustee. That means an extra expense, so it is better to settle if you can.

RIC: If I do move out, can I take some things, like dishes, towels, and urniture?

MARVIN: Well, they belong to both of you until the court orders otherwise. So, yes, you can take things, but I prefer you try to do it a little more smoothly. Make a list of what you want to take and let me discuss it with your wife’s attorney. Maybe we can have a move-out agreement. Or maybe we can try mediation.

RIC: OK. Set it up!

Act Three: The Mediator

Stephanie Silverstein is a lawyer who now only takes cases as a mediator. Brooke and Ric are seated at a round conference table in Stephanie’s office. A dish of candies sits on the table. Stephanie is standing by a blackboard with chalk in hand.

STEPHANIE (drawing a house on the blackboard): Now, what are we going to do about the house?

BROOKE: I’d like to stay in the house.

STEPHANIE: Are you prepared to buy out your husband’s interest in the house?

BROOKE: I would like to. But I have no cash. How can I buy out his interest?

STEPHANIE (sitting down): Maybe we can find something you can trade for his equity in the house. One of the reasons that mediation works is because people want different things. Let me tell you a story to show you what I mean.

Mary was a scientist working for a biotech company. She owned a lot of corporate stock in her name. She was married to Tom, an engineer. They owned a townhouse together. Mary thought the prospects of her company were exciting, and real estate was a boring investment to her. Tom, on the other hand, believed that stock investments were mercurial and that real estate was a more solid investment. The equity in the house and the stock were about equal in value so it was easy for them to agree that Tom would keep the house and Mary would keep the stock. They were each taking a risk on the future of their investments, but it was a risk they both felt comfortable taking.

BROOKE: That’s a good story, but I don’t have any stock to trade for the house.

STEPHANIE: No, but your husband owns a business and has a pension plan.

RIC: That’s right. I’m a partner in an accounting firm and I have a 401(k) retirement plan.

STEPHANIE: If the numbers work, you may be able to trade Brooke’s marital interests in the business and the pension plan for Ric’s interest in the house.

RIC: How will we know if the numbers work?

STEPHANIE: We can agree on the value of the house or we can have it appraised. The same goes for the business. The value of the 401(k) plan is on your last statement.

RIC: Who pays for the appraisals?

STEPHANIE: Since they are for both of you, it would make sense to split the cost. That’s better than going to court and each of you having your own appraisal done.

BROOKE: What about the mortgage?

STEPHANIE:You are going to have to take over the mortgage payments, real estate taxes, utilities, insurance, repairs, and maintenance on the house once it is transferred to you. We will have to keep that in mind when we mediate support.

RIC: How do I get my name off the mortgage?

STEPHANIE: That’s important because if you try to buy another house it will be considered a contingent liability. And even though Brooke agrees to pay the mortgage, if she misses a payment, it could affect your credit and the mortgage lender can ask you to pay.

RIC: So, what’s the solution?

STEPHANIE: One way to solve this problem is to give Brooke a certain amount of time to refinance the mortgage in her name alone. You agree that if she is unable to do so within that time frame, then she will sell the house.

BROOKE: How much time?

STEPHANIE:That’s up to the two of you to decide. Some courts will give the party that has primary custody of the children extra time in the house so as not to upset the children’s routine. Depending on the age and maturity of the children, it could be a number of years.

RIC: Will I have to pay taxes on the buyout?

STEPHANIE: No. Section 1041 of the Internal Revenue Code makes all property transfers, during a marriage or incident to a divorce, tax free.

RIC: What does “incident to a divorce” mean?

STEPHANIE: It means the transfer occurs within one year after the divorce or is related to the divorce. It is related to the divorce if it occurs within six years of the divorce and is contained in a separation agreement or decree of divorce. If the transfer occurs more than six years after your divorce or it is not mentioned in the separation agreement or divorce decree, then the IRS will presume it is not a tax-free transfer related to your divorce. However, you can still overcome this presumption if you have facts to persuade the IRS otherwise.

BROOKE: If the transfer of the house is tax free to me, will I have to pay taxes on Ric’s share when I eventually sell the house?

STEPHANIE: Brooke, you will have a carryover tax basis in the house after the transfer. The tax basis is used to calculate the capital gains tax when the house is eventually sold by you, and it is the cost of the house plus improvements and sales expenses. But there is an exclusion of up to $500,000 of gains after deducting the basis for a married couple when they sell the house as long as they meet two tests: The use test requires that both of you must have lived in the house for at least two of the past five years. The ownership test requires that one of you must have owned the house for at least two years. The exclusion is $250,000 of capital gains for single taxpayers or taxpayers filing a separate return.

BROOKE: What happens if we don’t sell the house for four or five years?

STEPHANIE: Ric could lose his $250,000 exclusion because he would not meet the use test for living in the house for at least two of the last five years.

RIC: I don’t like that scenario.

STEPHANIE: There is a work-around. If Brooke has a court order granting the use of the house to her, Ric can add her time in the house to his. Then, Ric can meet the use test. The IRS calls this tacking.

RIC: Can you give us an example?

STEPHANIE: Sure. Let’s say you both paid $200,000 for the house. If you, Ric, transfer the house to Brooke in exchange for her interest in your pension and your business, she will carry over your basis in the property. So, her basis will be the total cost of the house, or $200,000. If she sells the house for $600,000, her gain will be $400,000 (the sales price less her basis). She can exclude $250,000 of gain if she is divorced, which will leave her with $150,000 of gain. The capital gains federal tax is 15 percent, or $22,500, plus state taxes.

RIC: So, how do we avoid that?

STEPHANIE: One way to do it is this, Ric: You can both sign a separation agreement that provides that Brooke and the kids can live in the house for five years, and then they will sell it and you will both split the proceeds. If they sell it for $700,000, they will have a capital gain of $500,000 (the sales price less their basis). But now, you can tack Brooke’s use onto your own. You therefore pass the ownership test as well. So, both of you can each take a $250,000 capital gains exclusion and pay no taxes. That effectively gives you $22,500 more to negotiate with, courtesy of your Uncle Sam.

RIC: That’s very slick. I can see how this may work.

STEPHANIE: Yes, but Brooke, you will still have to be able to pay the mortgage. So, let’s talk about support.

Summary

The house is usually one of your most important assets. You can sell it, or one spouse can buy the other out. You can use other martial assets, like pension plans or business investments, to trade for equity in the house. Transfer of the house is tax free in a divorce. With tax planning, you can avoid taxes on the sale of the house.