One way individuals can reduce this stress is by becoming active participants in the decision-making process, rather than allowing themselves to become passive "victims." The level of the participation will depend upon whether the parties are able to resolve the issues through mediation. They may have to resolve some or all of the issues through litigation. Either way, each party to the divorce may use the classical management approach of identifying the problem, listing possible solutions, reviewing the alternative solutions, and selecting what appears to be the best result. Since divorce is an adversarial process, each party then may advocate the solution he or she deems most desirable either through mediation or litigation.

One of the major problems in a divorce procieeding is deciding what should be done with the marital home, which is for many couples their largest single investment.

Possible Solutions

Assuming that the parties are to share in the equity in the marital home, there are three apparent, viable solutions. One, the couple can put the house up for sale and share in the proceeds from the sale. Two, the party who is reviewing the alternative solutions may sell his interest in the marital home to his spouse as part of the divorce settlement. Three, the reviewing party may buy his spouse's interest in the marital home as part of the divorce settlement. There are, of course, other alternatives such as turning the house into a rental property, but they are not as likely and will not be considered here.

Reviewing Alternative Solutions

The review of alternative solutions requires an understanding of both the qualitative effects of the solution on the divorcing couple and their children, if any, and the quantitative or economic effects that the solution will have. To illustrate the complexity of these interdependent effects, a case example will be used.

Robert Palmer and his wife, Robin, have recently decided to divorce. They have been married for fifteen years, and have two children. Their son, Mike, is fourteen years old, and their daughter, Jill is six years old. The Palmers have agreed to splut custody of the children with liberal visitation arrangements. Mike will live with his father, and Jill will live with her mother. Robert is the sales manager for a surgical instruments manufacturer, and Robin is a purchasing agent for a food distribution company. He earned a salary of $45,200 in 1991, and she earned a salary of $33,600 in 1991. They have very little savings.

In 1985, the Palmers sold their residence for $64,000, and purchased a larger residence for $85,000. The previous residence was sold at a gain of $14,000. This gain was deferred in accordance with the federal tax laws, and the adjusted basis in the new residence for federal tax purposes was reduced to $71,000 (i.e., cost $85,000 minus deferred gain $14,000). The mortgage balance on their current residence is $56,800. An appraiser hired by the Palmers has estimated their house's current fair market value at $96,000.

Robert has analyzed the alternatives as follows:

Alternative 1--Sell their residence, and split the proceeds. Robert's initial "gut" reaction is that he prefers this alternative. He does not think Robin will be able to afford to buy his interest in the house from him, and he does not feel comfortable with the idea of taking on a second mortgage to buy Robin's interest.

If the Palmers sell the house, Robert estimates that they will each receive $20,900 based on the following computation:

Selling price of residence $96,000

Expenses of sale:

Realtor's commission $ 6,720

Other expenses 680

7,400

Amount realized 88,600

Mortgage due upon sale 46,800

Net cash proceeds from sale 41,800

x Equal share percentage 50%

Each party receives $20,900

Robert has consulted his accountant, and knows that the sale of the house is a taxable event generating a gain of $17,600 (amount realized of $88,600 minus adjusted baiss of residence of $71,000). However, his accountant has told him he may continue to defer his share of the gain $8,800 (i.e., $17,600 x 50%) if he purchases another residence at a cost at least equal to his share of the amount realized. Robert would have to purchase a residence which costs at least $44,300 (i.e., $88,600 x 50%). He also knows that if he holds his new residence until he is age 55 under current federal tax laws he would be eligible to exempt from taxation a gain of up to $125,000 on the sale of a residence. Robert likes owning a home, and if this residence is sold as part of the divorce process, he expects that he would buy a new residence and defer the gain.

Alternative 2--Sell Robin his interest in the residence. Robert sees advantages and disadvantages to this alternative. He sees the divorce as emotionally traumatic to his children. If Robin were to acquire his interest in the home from him, Jill could continue to live in the home. Robert believes that continuing to live in her neighborhood would mitigate the trauma of the divorce for Jill. She could continue to play with her neighborhood friends, and continue to attend her elementary school where she has established friendships. It may even alleviate some of the trauma for his son Mike who could visit his mother and sister in a familiar and comfortable environment.

Robert's accountant has told him that if he transfers his interest in the home to Robin as part of the divorce settlement, he would have no taxable gain and Robin would assume the predivorce basis in the home (*). Robert sees this as both an advantage and disadvantage. Since Robin assumes the adjusted basis in the property, she would become responsible for all of the deferred gain. The transfer of the adjusted basis in the residence to Robin relieves Robert of the gain on his share of the residence's appreciation in value. He sees this as an advantage.

Robert knows that Robin will have to obtain a second mortgage on the property in order to buy his interest. Furthermore, because of this additional financial burden, he is concerned that Robin may find out in the next couple of years that she cannot afford to continue to pay the insurance, interest, taxes, and maintenance on a home of this value. She may be forced to sell it for economic reasons and replace it with a smaller residence with lower costs. Robert sees this as a disadvantage because Robin would be subject to tax on the portion of the deferred gain not reinvested in a new residence.

For example, assume that Robin sold the residence for $100,000 in two years and after deducting the expenses of the sale she realized $92,000 on the sale. Also assume that Robin bought a new residence at a cost of $70,000. Robin would be taxed on a gain of $21,000 (amount realized of $92,000 minus adjusted basis of residence sold of $71,000).

Even though the couple is divorcing, Robert believes that what is in Robin's best interest is also in his best interest and the best interest of his children. He knows that the couple is interconnected economically because of the financial needs of the children and his legal and moral responsibility to provide child support. He sees the possibility of Robin being taxed on the gain as a probable event that could be avoided if the house were sold at this time. In that event, both Robert and Robin could buy a smaller replacement residence and continue to defer their individual shares of the gain. Both of them could avoid taxation of the deferred gain by selling their residences at age 55 or later.

Alternative 3--Buy Robin's interest in the residence. Based upon factors already mentioned, Robert considers this the least attractive alternative. Although it is an attractive residence in an attractive neighborhood, Robert does not want to assume the burden of a second mortgage in order to pay Robin for her interest in the home. Furthermore, he does not want to be responsible for the deferred gain should he find it necessary to sell the residence, and buy a less expensive replacement residence.

The Desirable Solution

Having reviewed the above alternatives, Robert believes that his initial reaction was correct. He believes it is in everyone's best interest to sell the residence at this time and split the proceeds and deferred gain. Then both he and Robin could each buy a smaller replacement residence and continue to defer their individual gain shares. This is the alternative that he will advocate for in mediation or litigation.

He considers selling his interest in the residence to Robin as a second best alternative that he would be willing to do if Robin strongly favored that alternative.

(*) See Sec. 1041 and related regulations for rules governing interspousal transfers incident to a divorce.