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“It Zigs, It Zags . . .” Even the typically exacting New York Times had a hard time describing the stock market’s wild swings  last week.

Without question, the volatility on Wall Street has us all a bit on-edge about the health of our investments. But for a woman going through divorce the anxiety can be particularly acute. How will declines in the stock market affect her divorce settlement agreement? What impact will portfolio losses have on her long-term financial well-being?

Now that everyone’s attention is focused on the ups and downs of the market, I think the timing is perfect for a quick primer on how stocks are divided during divorce. Here are a few things you need to keep top-of-mind:

1. Separate vs. marital property

Remember that some of your assets might be considered separate property, while most others are considered marital property. States differ in some of the details, but typically, separate property is:

• Property that was owned by either spouse prior to the marriage

• An inheritance received by the husband or wife (either before or after the marriage)

• A gift received by the husband or wife from a third party (your mother gave you her diamond ring)

• Payment received for the pain and suffering portion in a personal injury judgment

All other property that is acquired during the marriage is usually considered marital property, regardless of which spouse owns the property or how the property is titled.

(For a more complete discussion see this earlier post, The Difference Between Separate and Marital Property.)

So, what will happen to those shares of Microsoft your grandfather gave you when you were single and graduating from college? That depends.

In most cases, if the shares were kept separate and not commingled with your other investments — especially other shares of Microsoft that you might have purchased during your marriage –then it’s likely that they will continue to be yours, and yours alone.  (It would help if you have documentation that shows your grandfather gave them to you on a certain date and what the value of that stock was on that date.)

On the other hand, if you have commingled the shares with other stocks you and your husband owned together, they could be considered marital property. (This is especially true in those states that will consider whether the appreciation in the value of that stock was active or passive appreciation. Your husband might successfully argue that he helped you manage the Microsoft shares. For instance, he may contend that since he convinced you not to sell them on numerous occasions or to buy more on other occasions, he is entitled to a portion.)

2. Community Property State vs. Equitable Distribution State

How your assets are divided will also depend on where you live.

There are nine Community Property States: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Couples living in Alaska can “opt in” for community property, and Puerto Rico is a community property jurisdiction.

In a Community Property State, both spouses are typically considered equal owners of all marital property.

The remaining 41 states are known as Equitable Distribution States (also known as Common Law States).

In an Equitable Distribution State, if your name appears on an asset (the deed to a house, title to a car, or stock e.g.), you are considered the owner. However, your spouse has the legal right to claim a fair and equitable portion of those assets in a divorce.

The equitable distribution of assets may result in a 50-50 split of marital property, or it may not. The goal in an Equitable Distribution State is not a 50-50 split. The goal is a fair (equitable) distribution of marital property.

(For a more complete discussion see this earlier post, Do You Live in a Community Property State or an Equitable Distribution State?)

3. The cost basis of your stocks

One of the most important issues you need to understand is the cost basis of the stocks in your investment portfolio. The “cost basis” is defined as the amount you initially paid for each stock, and this original purchase price can factor significantly into your divorce settlement agreement.

Here’s an example to help me explain. Let’s say you have a $200K investment portfolio. At first, it may seem very fair and reasonable to say, “We’ll just split the portfolio in half, so each of us will get $100K.” But, the key question here is this: Which specific shares will be in your half?

If your husband is particularly savvy, he may want his half to only include stocks, mutual funds, etc. that are close to the original purchase price. In return, he’ll happily give you $100K worth of investments that have appreciated in value.

Why?

Because then you’ll be the one stuck paying capital gains taxes on those appreciated shares when you sell.

Let’s keep working through the example. Assume you and your husband initially paid $40K for the shares he now wants to jettison. That means your $100K portfolio has $60K in appreciation. The federal capital gains tax is currently 15 percent (and is likely to increase to 20 percent in the near future). 15 percent of $60K is $9K. So, if you stick with your husband’s plan, you won’t end up with $100K. You’ll only get $91K (and that’s before subtracting the additional capital gains taxes that are imposed by some states).

Because of the cost basis of the stocks, a 50-50 split may not be as equal/fair as it sounds!

Please note that the scenario I just described does not apply to 401Ks, IRAs and other retirement funds because all capital gains on investments within those retirement vehicles are tax-deferred. However, you will need to pay ordinary income taxes when you withdraw funds (no penalty if you are older than 59 1/2) from those accounts, unless the funds are in a Roth account.

You must take these future tax implications into account when doing the financial analyses and projections –even for tax-deferred retirement vehicles. $100K in a 401K is pre-tax money, and it is not worth as much as $100K sitting in a bank account (where taxes have already been paid).

4. The wording of the divorce settlement agreement

Pay careful attention to how your divorce attorney words your divorce settlement agreement. Their choice of words could have a significant impact on your finances.

For example, let’s say that the agreement states that you will get $100K out of a $200K stock portfolio. If, by the time that portfolio gets divided, those investments increase in value, you still get only get $100K as per the agreement.  Hypothetically, the $200K stock portfolio could increase to $250K by the time it’s divided, but because you agreed to $100K, that’s what you’ll receive –-instead of what was probably intended to be half (which after the increase would be $125K).

Wording is critically important. If the intention and agreement is for half, then make sure the divorce settlement agreement says half and don’t use a dollar amount (and vice-versa).

Wording can impact the valuation of stocks, as well. The vast majority of couples do not go to court to settle their divorce, and so they can address the date of valuation in their settlement agreement. Their attorneys should add language to account for any increase or decrease in valuations –and with something as volatile as stocks, it may make sense to have the valuation date when the divorce is finalized or as close as possible to it. (Another reason why it’s often better to use percentages rather than specific dollar amounts.)

If a couple does go to court, depending on the laws of that specific state, the courts do have broad discretion in deciding the date of valuation. While assets are often valued when litigation begins, if they appreciate or depreciate between the time the litigation started and when the divorce is finally granted, the court can make the necessary adjustments. However, this process can become extremely complicated, particularly if there is a long delay between the date of separation and divorce.

As you can see, you need to consider a number of very specific concerns when dividing stocks, mutual funds, etc.  At Bedrock Divorce Advisors, we take care of the critical financial tasks that are beyond the scope of your divorce attorney’s expertise, from preparing financial affidavits to projecting the financial and tax implications of different divorce settlement options. Our goal is to make sure you’ll be financially okay now and in the future –and so, a little less worried about the ups and downs on Wall Street, too.

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Jeffrey A. Landers, CDFA™ is a Divorce Financial Strategist™ and the founder of Bedrock Divorce Advisors, LLC (http://www.BedrockDivorce.com), a divorce financial strategy firm that exclusively works with women, who are going through, or might be going through, a financially complicated divorce. He also advises women business owners on what steps they can take now to “divorce-proof” their business in the event of a future divorce. He can be reached at Landers@BedrockDivorce.com.

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