Divorce and Illiquid Assets: Pathways for Progress
Dividing up what you’ve accumulated in a marriage is one of the harder parts of divorce. The simple stuff (“I don’t need to see your set of golf clubs ever again…”) quickly pivots towards shared assets that are harder to split. Liquid assets like cash, money market accounts, and marketable securities are straightforward. Illiquid assets like real estate, business equity, and substantial retirement funds are not.
Illiquid assets, integral to long-term financial ambitions and lifestyle, can’t simply be liquidated without consequence. You must understand your options—particularly regarding the tax implications.
What are illiquid assets?
Illiquid assets cannot be easily converted into cash without substantial time, effort, or cost. These assets are often complex to market, meaning there may be few buyers or a longer timeframe for sale.
Divorce and illiquid assets
Illiquid assets may hold emotional or sentimental value, adding layers of sensitivity to the division process. I previously helped a client through their divorce process by helping them split illiquid assets including a home and reserved stock units (RSUs). One person wanted to keep the house, the other wanted to retain the RSUs. While the house split was easy, the RSU split was more problematic as the person who wanted to keep the RSUs didn’t want to split the future value of their RSUs with their soon-to-be ex-. I helped this couple work through this by calculating the percentage of the remaining RSUs for the wife based on the years they were married while he was employed.
At Brighton Jones, we are well-versed in the complexities associated with dividing illiquid assets during a divorce. Our team of experienced professionals can guide you through the process and help develop strategies that align with your unique situation and goals.
Three considerations for valuing illiquid assets in a divorce
#1 The potential for future growth or decline in the asset’s value. This may require the expertise of a financial professional who can analyze market trends and provide insights into the potential future value of the asset. In the same way I worked with a couple on the expected future value of RSUs, I’ve also worked with couples on the potential appreciation of a family home and how to account for it in the transferring of assets.
#2 Asset liquidity. If one spouse wishes to keep the illiquid asset, they may need to offset its value by providing other assets of equal value to the other spouse. This can help to ensure a fair division of assets. For example, if one person gets the home, the other must receive assets of equal value and security. They may not want to transfer equities due to their volatile nature but rather look at capital preservation assets.
#3 Professional appraisals. The expertise of a qualified appraiser can provide an objective and accurate valuation, which is essential for making informed decisions during divorce proceedings. When the cost of a house influences the “trade-offs” against it, there is an incentive to ensure you have the most accurate value associated with it—regardless of whether you intend to sell it or simply use it to balance the total split of assets.
Alternatives for dividing illiquid assets
Selling the illiquid asset and dividing the proceeds: One alternative is to sell the illiquid asset and divide the proceeds between spouses. This approach can be straightforward, especially if both parties agree on the sale and the asset’s fair market value. It allows for a clean break and provides each spouse with their share of the asset’s value. I remind clients of the capital gains house exemption change for someone who was once married but is now single. If you sell a house together, as married, filing jointly, you can exclude up to $500,000; If you are single or filing separately, you can exclude $250,000. If you are only planning to keep a home for a few years, it may be beneficial to sell the house when you have a $500,000 exemption rather than the $250,000. (Inevitably, the selling or keeping of the family home comes down, for many, to more than just tax mitigation.)
One spouse retains the illiquid asset and compensates the other: In some instances, one spouse may desire to maintain a specific illiquid asset, such as a family home or a business. In this situation, the spouses can negotiate an arrangement where the spouse who wants to keep the asset compensates the other spouse with other assets or a lump-sum payment. Often, assets in a joint brokerage account can be used for this compensation.
Forming a trust or partnership to hold the illiquid asset: If both spouses have an ongoing interest in an illiquid asset, such as a jointly owned business, they can consider forming a trust or partnership to hold the asset. Some couples who want to open and keep together assets intended for kids, say, post-college graduation, will create two jointly owned accounts for the assets.
Tax considerations of dividing illiquid assets
#1 Considerations regarding capital gains tax
When an illiquid asset is sold, any profit may be subject to capital gains tax. Therefore, it’s important to determine the asset’s cost basis, which is generally the original purchase price plus any improvements made over time.
#2 Tax Consequences of Selling vs. Transferring Ownership
Another important factor is whether to sell the illiquid asset or transfer ownership. Selling an asset may trigger immediate tax liabilities, while transferring ownership may allow you to defer tax consequences until later. Consulting with a tax professional can help you weigh the pros and cons of each option and choose the most tax-efficient strategy.
#3 Utilizing tax strategies to minimize liabilities
Structuring a buyout agreement or utilizing a qualified domestic relations order (QDRO) may provide tax advantages in certain situations.
Creating a long-term financial plan
Creating a comprehensive long-term financial plan allows you to navigate the complexities of divorce and illiquid assets while meeting your financial goals.
Brighton Jones offers personalized financial planning services to help individuals going through a divorce create a plan tailored to their unique circumstances.
Contact us today to learn how we can assist you in moving forward.
