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Posts Tagged ‘Cash Flow’

Divorce is emotionally traumatic on everyone involved especially if there are children.  While it may seem mundane, dealing with the money and tax issues that arise from the unwinding of a life together is as important for both psychic and fiscal sanity.

In the big scheme of things, there are more important things than money.  And many who are faced with this kind of life-changing event will cope by simply ignoring the details, shutting down trying to avoid confrontation and more emotional pain. The personalities of each person involved (including family, friends and lawyers) will come out to wreak havoc.  And if someone was a submissive person, then they may become more withdrawn from the process.  Someone who was more dominant in the relationship will likely be more so.

If I’ve learned anything from years of working with people and their money, it is that money is emotionally charged.  And while it may seem satisfying to try to extract some sort of revenge for the pain by attaching a price tag to impose on the other spouse, it is more important to get to closure and strike a deal which best positions each person for moving ahead.

I’ve often said that life is a journey.  And along this journey we’ll each encounter all sorts of things.  A divorce, like any other sudden, life-changing event, is just another part of the journey.  And while we cannot plan perfectly for this or anything else, we can prepare.

So it is with divorce.

I’ve written in the past about the critical mistakes that divorcing couples will make that can set them up for financial failure now and as they start the next stage of their new life.

Dealing with the Family Home in Divorce

For many the key to the settlement is the home.  While each may want to keep the home, it may be wiser to consider other options. For some, there may be sentimental reasons for keeping the home or emotional reasons and bad memories prompting one to put physical and emotional distance between themselves and the home.

For many, the main reason to keep the home is to avoid further disruption especially if there are kids involved which might entail changing schools or at the very least dealing with a move while school is in session.

Financial Triage

Despite the pain, you will need to step up and deal with these issues.  Otherwise, there is a greater risk that the financial foundation put in place for your post-divorce journey will simply not stand up.

At the very least it is important to make sure that all legal documents properly reflect who is responsible for the debts and bills associated with the property going forward.  This means contacting the utilities to change the name on the account.  In the event that the marital home was a rental, then make sure that the landlord changes the name on the lease. Get confirmation in writing.  Otherwise, there is the risk that an unpaid bill may end up in collection and lead to a black mark on your credit report.

The same can be said for credit cards.  It’s in everyone’s best interests to contact the credit card issuer to freeze the account to any new charges.  Don’t forget about old credit cards that you may not use or can’t find the actual plastic card.  To help with this get a copy of your credit report and make contact with each listed creditor appearing on it.

For property that is owned or mortgaged, this becomes a little more tricky.  The mortgage company won’t simply release someone from the debt not even with a valid final divorce decree.

In this case the only way to get this liability off your back is to sell the property or through a cash-out refinance by a spouse who will then assume the ownership and debt solely.

And as long as you are both on the deed, then the property tax liability and even water, sewer or other municipal charges will be the responsibility of each of you.  Only when the property is sold or refinanced will these liabilities be behind you.

Keeping the Home: Will It Make Sense?

A lot of my divorce financial planning practice centers on this very question.  Now if someone insists on keeping the home, I’ll spend a lot of time modeling the impact on near-term cash flow and long-term financial security.  It is not a guarantee that keeping the property is the best option.

It may not make sense at all.  There are the costs of running a home now on one source of income.  Even if one is receiving alimony to supplement this, it may not last long.  There are the added costs for maintenance that may need to be done by outside vendors that were once done by the spouse “for free” before such as snow removal, lawn care, repairs or house cleaning.

And while there may be support payments expected as a source of cash flow to cover these costs, what happens when or if your ex-spouse is unable to pay or simply decides to stop paying? Sure, there are legal remedies.  But these take time and cost money.  In the meantime, the bills may pile up and risk not only your credit.

In some cases, an ex-spouse may continue to provide help in these areas.  But they may want to negotiate the classic side deal: Do the repair and deduct it from the support owed.  This isn’t proper and will not help your long-term cash flow. In some cases, the ex-spouse will try to claim the funds used for these repairs as part of alimony so that it can be a tax-deductible expense.  This is also flat-out wrong and distortion of the tax and divorce rules.

Selling the Home May Make the Most Sense

It may be easier and wiser to simply sell the home, split the proceeds, pay off outstanding debts, fund the emergency reserves and start off fresh without the added burden of running a home.

And while not seeming to be critical in a time of depressed real estate values, by keeping the home you risk losing out on a very valuable capital gains exclusion on the sale of property.  As long as you’re married when you sell your home, the first $500,000 in gain above the original purchase price and subsequent costs of improvements will be exempt from any capital gains taxes.

Once you are divorced this exclusion drops to only $250,000.  For those couples who bought homes several years ago before the huge run up in values, this may be a critically important consideration.

Seek Professional Guidance

Dealing with the many tax, financial and real estate issues related to a divorce can be complicated.  You may want to seek advice from someone specifically trained to handle such issues.  Not all CPAs, attorneys and financial planners are qualified or set up to help clients through this type of life-changing event.

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Shakespeare was right.  In Hamlet, one character, Polonius, counsels his son “neither a lender or borrower be.”

While not entirely realistic, then or now, it does have a grain of truth in it.  Too much debt limits one’s flexibility and options.  If you borrow too much, you are forced to service that debt with resources that can’t be used for other things.  If you lend too much, you are at risk of never seeing your money again (or being forced to take less when your borrower defaults).

Cash Flow Impacts Personal, Corporate and National Choices

This is as true for individuals as for sovereign nations and corporations. You can’t eat your shoes or your car.

You may have assets but without cash flow, the grease that keeps the system running smoothly, you can only keep going for so long.  Just ask your neighbor who has lost a job and run out of unemployment benefits.  While the house, car and stereo all are assets with value, unless he can turn them into cash he can’t use them to eat. And when you’re forced to sell them, don’t expect to get the same sort of cash money price for them. Boon to the buyer but not to the seller.

Debt Crises and Dominoes

Earlier this year, the banking crisis in Greece occupied the top spot in the headlines.  While a loan from the EU backed by the Eurozone’s largest and most healthy economy so far, Germany, placed a bandage over the immediate crisis, structural problems persist.  This has led the Greek government to roll out a number of stringent and very unpopular austerity measures.

At the time, the open question was how would this crisis in Greece impact the rest of Europe.  No country in the developed world has been spared by the current global recession and slow down.  Would this create a domino effect where weak economies lost the faith of the markets and were forced into their own crises?

The Story of the PIIGS – Scarier Than the Bedtime Story

The targets to watch were the PIIGS of Europe:  Portugal, Ireland, Italy, Greece and Spain.

Each of these economies have structural deficit issues and are the weakest links in the Eurozone chain.

Just like the children’s tale, these little PIIGS are threatened with being gobbled up but in this case by the firm hand of the market in the form of higher interest rates and loss of investor confidence needed to keep their debts financed.

Sure, there is the potential for bailout from other Eurozone members. While Germany continues to be a relatively strong economy, it alone cannot support all of these economies.

So Ireland is the latest victim to the excesses of easy credit.  Now their economy and banks are saddled with real estate loans gone sour and no one to buy the leftovers. Even Great Britain, not part of the EU, has its own issues that they are trying to tackle by implementing severe cuts in their social services, government programs and employment.

Cash Flow and Jobs Closer to Home

Looking back to 2008, the loss of faith in the financial system by nearly everyone cut off the money lifeline to otherwise solvent businesses.  Companies with lots of assets (real estate, machinery, equipment and workers) lacked the cash to continue operations.  Typically, a business (and governments, too) finance themselves from short-term borrowing to cover operational and payroll costs while waiting on the collection of accounts receivable.

But when the faith in getting repaid dried up so did the credit forcing many to the brink.

Eventually, here in the US we saw the Fed and the federal government step in to provide the needed liquidity to the system.

Now while other economies are being forced to make unpleasant choices about their economic structure and priorities, we in the US continue to avoid any real adult discussion about our own issues.  Since market investors continue to buy up our public debt, we continue to run as if nothing has changed.

As the world’s primary reserve currency, we continue to benefit from the world’s use of the US dollar as a safe haven.  But as has happened to Greece, Ireland and companies like Lehman Brothers before them, a flick of a switch can change investor sentiment and the near-term financing needed to keep our economic engine running can be shut off.

Whether or not this will lead the political classes to do what is right in the long-term (beyond the next election cycle) to get our finances in order is another open question.  The President’s debt commission has come out with a number of laudable, if not popular or pleasant, options that offer ways to share the pain to make sacrifices that will keep us on track for continued economic growth and national security. Unless we follow through and take up the hard choices that have otherwise been forced on other nations, we risk our own crises more nightmarish than we have seen as we are forced to make bad or worse choices with limited options.

Let the adult conversation begin.

 

 

 

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