Dividing assets during a divorce is always complex, but in high asset divorces, the stakes are even higher. These cases often involve large financial holdings such as real estate, stocks, business interests, and retirement accounts. While it may seem simple to split these assets down the middle, one common mistake many people make is failing to account for the tax implications of these transfers. Not all assets are created equal when it comes to taxes, and overlooking this can lead to unexpected financial burdens down the road.
Stocks and Capital Gains Taxes
If you or your spouse hold substantial investments in stocks, it is important to understand the tax consequences of liquidating or transferring these assets. When stocks are sold, any profit made from the sale can be subject to capital gains taxes. The rate depends on how long the stocks were held before the sale – short-term gains (held less than a year) are typically taxed at a higher rate than long-term gains. This means that the party receiving the stocks in the divorce could face a large tax bill if they decide to cash them out.
Let us say your spouse receives $500,000 worth of stocks as part of the divorce settlement, but when they sell those stocks, they owe $100,000 in capital gains taxes. That means the true value of the stock was actually $400,000, not $500,000. This is why it is critical to consider the after-tax value of stocks when dividing assets.
Real Estate and Property Taxes
Real estate is another area where tax consequences can catch people by surprise. If one party is awarded the marital home or other property, they need to consider more than just its market value. If they decide to sell the home later, they could face significant capital gains taxes, especially if the property’s value has appreciated over time.
Maintaining ownership of the marital home or other real estate after a divorce also comes with ongoing financial obligations, including property taxes. These taxes must be paid annually and can increase over time. For the spouse who keeps the home, managing these costs on a single income can be challenging, particularly if their financial situation changes after the divorce.
Retirement Accounts and Early Withdrawal Penalties
Retirement accounts, such as 401(k)s and IRAs, are often significant assets in a high asset divorce. However, withdrawing funds from these accounts early (before age 59 ½) can result in both income taxes and early withdrawal penalties. For example, a person who withdraws $200,000 from a 401(k) to cover expenses post-divorce could end up paying thousands of dollars in penalties and taxes, drastically reducing the actual amount they receive.
To avoid these penalties, retirement accounts can often be divided through a Qualified Domestic Relations Order (QDRO), which allows the funds to be transferred to a former spouse without triggering taxes or penalties. Working with an experienced attorney and financial advisor helps to divide retirement assets properly and protects both parties from potential tax consequences.
The Importance of Professional Guidance
The financial implications of a high asset divorce can be overwhelming, and tax consequences add another layer of complexity. Unfortunately, many people focus on the face value of assets and fail to consider how taxes can reduce the true value of what they are receiving. This can lead to unequal divisions of property and unexpected financial hardships.
Consulting with financial experts, such as a certified divorce financial analyst (CDFA), can help you evaluate the true, after-tax value of your assets. By doing so, you can make informed decisions that protect your long-term financial health. These professionals can also assist in creating strategies for minimizing tax liabilities, so you are not left with an unanticipated tax burden after the divorce is finalized.
At Irwin & Irwin, we understand the challenges you face when navigating the division of high-value assets. Our team works closely with financial professionals to help our clients fully understand the financial impact of their divorce, including tax implications. We believe in providing comprehensive guidance so you can make decisions that serve your best interests, both now and in the future.
If you are going through a high asset divorce and are concerned about how taxes may affect your settlement, contact us to schedule a consultation. We will work with you to help protect your financial future.
