By Harvey S. Jacobs May 1, 2010
While divorce can be an emotional roller coaster, the one area that needs reasoned, dispassionate, businesslike treatment is what to do with the real property assets of the divorcing duo.
The same principles apply whether the property in question is a modest condominium serving as the couple’s principal residence or a large portfolio including vacation and investment properties. The most important thing to remember: Never sign over your ownership interest in any real estate until your obligation to pay the outstanding loans secured by that real estate have been paid off or otherwise accounted for in the property settlement agreement.
Too often, one spouse agrees to convey his or her interest in the marital home without remembering that the mortgage was taken out by both spouses. Until that mortgage is paid off, typically through a refinance, or is assumed by one spouse in a transaction that expressly releases the other from liability for the mortgage, a divorcing spouse will remain legally liable for the entire mortgage (as a co-borrower) but will have conveyed 100 percent of his or her ownership interest. This presents the worst outcome: being left with the debt on the home but no home.
The reason that the conveying spouse will be liable for 100 percent of the debt is that virtually all promissory notes signed by both spouses have language that states that the parties “shall be jointly and severally liable for the entire debt.” That means the bank can go after just one spouse for the entire note balance. Sure, the party that gets stuck paying the whole note can seek to recover half of what was paid from the other spouse, but depending upon financial circumstances, that might not be possible.
Another principle is to make sure that the rights and obligations that go along with possessing the property are clearly specified. If one spouse is to remain in the marital home for a period of time before selling it, details such as how long the person can remain in the home and responsibility for paying outstanding mortgages, taxes, insurance, utilities and condo or homeowners association dues must be spelled out. The divorcing spouses also must agree on who will be responsible for repairs, landscaping, pest inspections and other maintenance.
If improvements will be needed to get the property ready for sale, the property separation agreement must identify who will approve them and who will pay for them. The last thing a divorced couple will want is to be forced to discuss and agree upon paint colors. When one spouse is buying the marital property from the other, this transaction should be documented with a promissory note, deed of conveyance and, unless it’s a cash buyout, with a deed of trust recorded against the marital home. If one spouse needs to borrow money to buy out the other, the selling spouse must make sure that all prior mortgages are paid off and that the new financing obligates only the buying spouse.
If one spouse not buying out the other and the property is going to be sold to a third-party both parties will need to sign all the sales documents, including the listing agreement, disclosure documents, the sales contract, the HUD-1 settlement statement, and of course, the deed of conveyance.
If the spouses simply do not wish to spend that much time signing documents together, a power of attorney can be used to grant legal power to another trusted person.
If there are mortgages on the property, the divorcing spouses will need to analyze whether the net sale proceeds will be more than the outstanding balances of all the mortgages. If so, they will need to decide how to split those proceeds. But in these economic times, the negative-equity scenario, in which the mortgage debt exceeds the net sales price, is an all-too-common occurrence. The spouses will need to agree on who will handle those deficiencies and how. For example, will both spouses need to bring cash to the closing table?
More subtle, but equally important, the parties must agree on who will bear the tax and credit consequences of a negative-equity scenario. Losses on principal residences are not deductible for tax purposes, but losses on investment properties can be deducted against investment income and may be of greater value to the spouse who has the most investment income. All these factors should be addressed in the comprehensive property settlement agreement.
Finally, the timing of the divorce and property sale needs to be carefully analyzed to ensure that the spouses get all available tax benefits. For example, under the IRS code, a married couple filing jointly may exclude up to $500,000 of capital gain upon the sale of their principal residence. To qualify, each spouse must have owned and lived in the residence for at least two of the previous five years from the sale date. So if the marital property is to be held for a period of time after the divorce is final, or if the property has not sold after the divorce but one spouse moves out, care must be taken to ensure that the property is sold before the two-year-residency period expires. For divorcing spouses who fail to meet the two-year-residency requirement, the IRS does provide for a pro-rated exclusion.
For more information, download IRS Publication 523 “Selling your Home” from http://irs.gov.
Harvey S. Jacobs is a real estate lawyer with Jacobs & Associates Attorneys at Law in Rockville. He is an active real estate investor, developer, landlord, settlement attorney, lender and Realtor. This column is not legal advice and should not be acted upon without obtaining your own legal counsel. Contact Jacobs at (301) 417-4144, firstname.lastname@example.org or ask@theho