May 1, 2014
Remember the old adage “never judge a book by its cover?” This holds true when looking at the value of a taxable investment asset. It can look like one thing on the outside, but can turn out to be completely different on the inside.
In this situation we are talking about investments such as stocks, bonds, mutual funds, collectibles and investment real estate that are held in individual or joint name, or in a trust. Such assets are subject to taxation when sold. If the asset has a gain and has been held for more than 1 year it is taxed at capital gains rates, which are typically 15% (with the exception of some collectibles which are taxed at 28%.) If it has a loss, that loss can be used to offset other gains as well as some ordinary income. To consider only the gross value, without taking into consideration how the gain or loss will impact the party’s taxes, does not give your client the full picture of what he or she really owns.
As an example, Dan and Jennifer have a joint investment account with $50,000 worth of stock that has a cost basis of $10,000. Dan is going to keep this account in the divorce. He is a high earner, grossing over $200,000 per year and is in the 28% tax bracket. Thus when Dan sells the stock he will owe 15% income tax on $40,000, or $6,000. That brings down the value of the account to $44,000.
Jennifer works part-time and makes $25,000 per year. She is in the 10% tax bracket due to her low income and some substantial deductions. If Jennifer had received this account, she too would realize $40,000 of gain when she sold the stock. However she would pay no capital gains taxes – taxpayers in the 0% or 10% tax bracket pay no capital gains tax – thus realizing the full $50,000 value of the account.
Tax losses can have the opposite effect. In the example above if the account had a cost basis of $75,000 Dan would benefit more from the tax losses, because he uses those to offset other gains (thus saving 15%) and may also be able to use some of it to offset ordinary income (saving him 28%). Jennifer would see less benefit as she pays no capital gains anyway and is in a lower ordinary income tax bracket.
If the account is split between the parties, each party is awarded the cost basis that pertains to the particular investment position that person keeps. In this case it is beneficial to take a careful look at each position in the account to calculate the gain or loss, and award each position in the most tax-beneficial manner.
The value of an asset can change when its cost basis is considered. The “after-tax” value can turn a valuable asset into a tax burden or, on the flip side, become a benefit to keeping the investment property. A Certified Divorce Financial Analyst can help you and your clients determine the true value of their investment assets.
