If you and your spouse do not want to sell your real estate holdings, you need to address the following issues in your settlement structure:
- Will one piece of real estate appreciate more than another?
- What type of tax attributes are associated to each piece of real estate?
- Do the properties have the same level of equity in them?
- What happens when the properties have different mortgage balances outstanding?
- What happens when there are different types of collateral associated to the properties?
- What do you do when the properties are cross collateralized against other assets or the same properties?
- What happens when the interest rates are not the same? Or one rate is variable and the other is fixed?
- If the mortgage payments are not equal over time how do we address this?
- What happens when the time horizon to pay off the mortgages are not the same across the properties?
- How do you incorporate different real estate taxes associated to each property?
- What happens with any environmental liabilities associated to the properties?
- Who should incur future replacement costs such as a new roof or costs around sewage pipes?
- What happens if the town changes their laws placing unexpected burdens on your property?
- How does a property with rental income get included in the marital estate? What happens if there are passive losses associated to this rental property? What if someone else own’s the rental property with your family?
With all of these moving variables, who gets what and when? How should you allocate the real estate between the two parties? Are there any other stakeholders associated to the properties that have to be taken into account before a decision is made?
Should the terms and conditions of a divorce decree be set in stone?
Most people draft their divorce decree with an objective to lay the terms and conditions in stone as of the settlement date. Although this might make sense for many situations, when there are many moving parts it can pose risk to you and your family. Why?
If anything changes after the divorce is finalized (e.g. the value of one property is appreciates more than another) then the party who had the lesser valued property is ‘out of luck’. Is that the way this should work? If that happened to you, would you build resentment toward your former spouse? If so, your resentment should not be directed toward your spouse. It should be directed toward the process that was used to create your settlement structure. How do you prevent yourself or your spouse from having this type of experience?
Before you can determine how to properly allocate the real estate between the parties, you have to answer a lot of questions. Unfortunately it is usually not as simple as “you take this piece of real estate and I’ll take that one”. If you take that approach, as time marches on resentment will set in. You will question why your spouse got a better deal than you did. A situation that was meant to be amicable from the outset just shifted. The reality is you have to put all of the issues on the table and analyze them together to figure out the right solution for you and your family.
Different ways to manage the moving parts in your marital profile
The options listed below are not based on your specific situation. So, please keep them in context as you read them. Your situation likely needs to be ‘designed’ to arrive at the right solution for you and your life. We call this an ‘architectural problem’ that just has to be analyzed.
Here are a couple of options to consider. These options are highly dependent on the stakeholders involved and the attributes of the properties. Again, they may not apply to your specific situation so you have to be careful before moving forward.
Option 1 – Build into your divorce decree clauses that allow you and your family to experience the benefit of the market. This way you can keep the wealth in the family and reconcile the money over time. You would only make this decision if you had foresight as to where the market will be going which can be difficult. You also need to have clear definition in your divorce decree how you and your spouse will reconcile and allocate the benefits you gain in your real estate holdings.
Given the variables involved as defined above, this option requires a professional to be a process expert in financial matters specifically related to divorce proceedings. Why?
When you create a divorce decree the language inside the document should be ‘process driven’. In other words, what ‘process’ should you employ if/when scenario A arises or scenario B arises later in life? You will live by your divorce decree. That’s why clear process is critical.
Defining clear processes is important to create a divorce decree that works for you. If Option 1 made sense for you then you would need to define the processes in the divorce decree to address what happens as one or more variables, as defined above, change. You will have financial dependencies that will need to be addressed. If you pursued Option 1, you will also have to build in the right measurements and appropriate target dates into your divorce decree so you can ‘re-measure’ where things stand at a future point in time. What needs to be measured is a good question to ask. This is relatively easy for a professional who has an analytical mind as you are developing your mutual agreements.
Option 2 – Simulate the sale of one or more of your real estate holdings. This requires you to incorporate everything into the simulated transaction as if it happened as of the settlement date (the effective data of valuation). You may have to build in contingencies for things such as aging pipes, planned real estate tax assessments, furnace replacement, etc. where appropriate. Put together an honest assessment of the quality of each piece of real estate including any potential liabilities you might encounter. Then design a transaction structure that takes into account all of the variables so you can logically allocate the monies between the parties.
This second option requires a professional who understands how to simulate the sale of the different pieces of your real estate investments. It would be important to incorporate the terms and conditions of your mortgage, any replacement costs, among other factors into the transaction structure. It is not as simple as adding a few numbers together and arriving at a decision. It requires careful thought to avoid overpayment to/from your spouse and a lifetime of unintentional resentment.
Throughout this process, it is important to develop a strategy to separate yourself from your mortgage provider too. This creates a whole set of issues around collateral constraints, covenants and the income required to maintain the mortgage. Careful planning is critical in these situations so you do not put yourself in hot water with your mortgage provider. There are likely other stakeholders in your life that you have to incorporate into your divorce process. Thinking holistically about these issues will minimize your risks and optimize your outcomes.
How will you communicate your complex thinking to your spouse?
To arrive at the right outcome, both approaches require critical thinking and analysis. After you figure out the solution, you will need to figure out how to demonstrate your logical progression of thought to your spouse. How will you communicate this information if your spouse does not have the background to understand what you are saying? If you can’t figure this out you may not get the buy-in you need to move forward and run the risk of your divorce going on and on. A professional who is skilled in the art of financial communication in divorce processes is key to have on your team.
About the Author
Larry Smith is a Founding Partner of Divorce Outcomes, a specialized professional services firm that manages all of the financial aspects in a divorce process. Since 2003 he has worked as a trusted financial advisor, financial advocate, divorce architect and technical financial expert; he is not an attorney. He is an alumni of KPMG and Andersen with expertise in technical accounting, forensics, sophisticated taxation, management consulting, risk management, advanced process engineering, business combinations, divorce management, multi-party negotiations, advanced quality analytics and cognitive performance technologies. Since 1986 Larry has been advising individuals and organizations about innovative financial solutions to resolve complex financial challenges that arise in life and in business.
For both personal and business divorces, Larry is considered an expert in divorce strategies, divorce process management, financial divorce architecture, financial risk management, taxation for divorces, financial divorce forensics, advanced divorce analytics, financial divorce negotiations and mediation, business valuations and sophisticated equity structures. He helps clients shape complex financial decisions, manage communication risks and ever-changing negotiating positions to strategically preserve or grow wealth from these types of transactions.
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in their divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients manage their divorce process, uncover hidden financial risks, architect divorce solutions, manage ever-changing negotiating positions, communicate complex financial matters and close the divorce process as soon as possible with a goal to arrive at the best outcomes possible. Throughout the process we evaluate the current state of our clients’ financial lives with an objective to best reposition their future. We do not sell any products. We simply raise issues that are in our clients best interest. Our clients share with us we:
- unfold, analyze and repackage their financial life so they are well positioned after their divorce
- preserve the value of their business or marital estate
- continuously strive to provide a return on our services
- build balanced financial solutions grounded in evidence
- find ways to make our client, and at times both parties, money through the process
- design their divorce to work for them and their family’s life
- provide mental clarity to make decisions
- reduce the total process time from start to close
- minimize the stress and unpleasant memories that can last a lifetime
As we reach an agreed upon settlement structure, we help our clients identify a fitting attorney who can leverage the financial solution to draft and record the requisite legal documents. Where outcomes are at risk from a traditional process, we function as expert financial negotiators or financial mediators to turn around the situation and achieve our client’s desired outcomes.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.