Financial Divorce Professional Newsletter

August 2009

Table of Contents

1. Divorcing Couples Can Avoid the 10% Penalty on Retirement Fund Early Withdrawal
2. New Tax Law Concerning Turning Rentals into the Family Home
3. Another New Tax Law
4. Another Madoff Story
5. Thought for the Day

Divorcing Couples Can Avoid the 10% Penalty on Retirement Fund Early Withdrawal

Often when couples divorce, there is a retirement fund that needs to be split. This can be an excellent source of money for a down payment on another house. However, normally these funds are subject to a 10% penalty tax by the IRS for "early distributions", if the funds are disbursed before the participant is 59 1/2 years old.

In a divorce situation, there is often the opportunity to withdraw money and avoid the 10% penalty. Let's say that Sarah and John are getting divorced, and Sarah is getting half of John's 401k which is worth $640,000. Sarah's half is worth $320,000. If Sarah needs to take $100,000 in cash for a down payment on a house, there is a special rule for divorcing people that enables her to take cash without having to pay the 10% penalty. In Sarah's case, it saved her $10,000 in penalty fees!

A Certified Financial Divorce Practitioner can help your client discover exactly how to take advantage of this opportunity. However, it is important to know that this opportunity to avoid the 10% penalty tax is only available before the money is transferred to another account, so your divorcing client needs to be aware of the opportunity before it is too late.

If there are no other assets and your divorcing client wants a down payment for a house, this is a good source of funds to know about.

New Tax Law Concerning Turning Rentals into the Family Home

A new tax law regarding rental property went into effect January 1, 2009.

Assume that Paul and Karen are getting divorced in December 2008. They own several rental properties. Karen is to keep one of them and she decides to move into rental.

It used to be that if Karen wanted to sell the house after 2 years, she could apply her full $250,000 exclusion against the gain. But now the IRS wants part of those capital gains taxes that were accrued during the time it was rental property, starting January 1, 2009.

Scenario #1: Karen moves into the rental in December, 2008. She sells this property in March 2011. There is a $240,000 capital gain which she is able to wipe out with her $250,000 exclusion because the house was not a rental as of January 1, 2009.

Scenario #2: Karen does not move into the rental but continues to keep the property rented out as she wants the rental income. Four years later in 2013, she moves into the rental. Two years later in 2015, she sells this property. There is a $240,000 capital gain. She is only able to able to wipe out 2/6 ($80,000) of the capital gain with her exclusion. She will have to pay taxes on the remaining $160,000. And she will also have to pay tax on depreciation recapture.

Another New Tax Law

This comes from the AARP Bulletin. In December 2007, the Mortgage Forgiveness Debt Relief Act was signed into law that changes the length of time widowed homeowners have to sell their house. Previous to passage of this law, a home had to be sold the same year as a spouse's death to qualify for the $500,000 exclusion. Now, widowed homeowners have up to two years following a spouse's death to sell their jointly owned home and be able to exclude $500,000 from taxable gain. This change should allow recently widowed homeowners more time to grieve and better plan their future, instead of rushing a home sale to avoid paying more taxes.

Another Madoff Story

From the May edition of the ABA Journal comes this story:
When a prominent Manhattan attorney, Steven Simkin, divorced his wife of 30 years, he wanted a clean split. They had a large account that had been under the management of Bernie Madoff and in 2004 it was worth $5.4 million. So Simkin wrote his ex-wife a check for one-half, or $2.7 million. So she got the money and his half ended up being worth nothing!

Thought for the Day

Your words, your product and your service are symbols of what you believe in and what you stand for.
-- Larry Winget