My divorce settlement gave my ex the house but I hold a lien on it as my portion of the settlement. Do I have to pay taxes on that money when he pays the lien off?

[Opus 17 · Accepted solution]

Either you own the home (or a share of it) or you don't.  A lien (normally) is not ownership, but it gives you the right to step in and assert ownership if certain conditions occur.  (For example, a mortgage includes a lien that allows the bank the right to step in and assert ownership if you stop making payments.  The bank does not own your home unless they assert ownership by foreclosing.)

If your ex was awarded the entire house then I don't know why you were given a lien -- presumably to enforce some kind of monetary right you have, such as to be paid a certain amount of alimony, or to be paid a certain amount when the home is sold.  Can you add more details?

[wmhall82]

My ex did not have the ability to refinance at the time of the divorce, not have the cash to buy my share, and we did not want to sell for the sake of the children still living there. There were no other assets that could be exchanged for its value. So technically I am still on the mortgage,  but I have signed legal documents that say the house is his, he signed documents that he is the party responsible for it and the mortgage, and I hold a lien that he must pay when he sells, refinances, or by a due date...which is when the youngest child is no longer a minor.

[Carl]

Overall, this sounds more like a legal issue than a tax issue, where the legal issues may or may not create a tax liability depending on the terms of the settlement. So seeking the advice of a tax attorney (Not a CPA or EA) may be the route to go for a definitive answer to your query.

[wmhall82]

If he doesn't meet the due date, I can force a sale. But he plans to sell soon, so.

[pk]

As I read this and the comments by @Opus 17  & @Carl , I see the situation slightly different.  To me it is a legal document that allows you to enforce  collection of your share of the marital estate.   When you collect your share of the proceeds owed to you , it is  your money and after tax as such. Thus I see no reason for any tax.  It is not different than if the house was sold time of divorce and you were paid your share -- not a taxable event.  However, you would still need to consider  your original basis  -- say you bought the house for 400,000 and your ex sell the house  for 500,000 and pays you 50% of the proceeds ---$250,000.  Then you have a gain of 50,000 that may be taxable ( depending on the timing of the sale) -- a capital gain .  On the other hand if the divorce agreement says that  your ex has to pay you $250,000 and he just pays that to you  at some time in the future, then it may or may not be a capital gain.  Suggest you consult a tax professional when you receive the payment.  

[wmhall82]

The lein amount is a set value based on the equity in the property and appliances at the time of the divorce, rather than a percentage of a future sale.

[Carl]

@pk it's like I said - more a legal issue than a tax issue. As you know, not all divorces are the same state to state based on differing laws. Even if the state doesn't tax personal income, the treatment of monies and the such by state law, can have an impact on federal reporting of those monies/assets. For the most part, there's nothing taxable or reportable on a division of assets. However, this situation seems to go beyond that with a lein that could (and most likely will) have an impact on the reportability of that division of assets. I could write a book on this and all the possibilities running through my mind right now. But don't need to further complicate what I see as an arleady complicated issue here.

[Opus 17]

I think you don't owe taxes, but read on.  (I'm also mad at your attorney, if you had one.)

Here are two ways this would normally work.

1. the home is jointly owned.  You transfer ownership in return for an immediate payment.  The transfer payment is not taxable to you or deductible to him since payments made to equalize assets are not taxable or deductible.  When and if he sells, any capital gains tax is solely his responsibility.  

2. You retain your half-interest ownership until the home is sold, whenever that is.  At that time, each of you is responsible for half the capital gains (if there are any) and you can each apply your $250,000 exclusion toward your part of the gain, unless you are disqualified from using the exclusion for some other reason.

You did something different, and in my mind, dangerous and stupid.   It sounds like you transferred ownership for the promise of a future payment, and to guarantee the payment, you took a lien.  This was a very bad idea and leaves you in a much weaker position than either scenario above.  For one thing, you are still on the mortgage, meaning you are obligated to pay for a home that you do not own.  If your spouse stops paying the mortgage, you lose everything unless you pay up on a home you don't own.  Secondly, your lien is secondary to the bank's lien on the first mortgage (because no bank would agree to make themselves secondary to you).  That means that, if he stops paying and the home is foreclosed, you get nothing on your secondary lien unless the bank is first made whole on their primary lien.  For example, suppose the home is worth $200,000 and has a $100,000 mortgage.  If it goes into foreclosure and the foreclosure sale results in a payment to the bank of $101,000, the payoff on your lien is $1000 and that's all you get.

Or, suppose your spouse takes out a second mortgage and then dies or runs away.  He can take out the second mortgage without your permission because you are not an owner, but your lien would be almost worthless.

Giving up ownership while being obligated on the mortgage is a bad strategy and your attorney was not smart to agree to it, unless your attorney raised these objections and you decided to agree to it anyway.

This could also result in higher taxes for your ex since, as sole owner, he can only exclude $250,000 of gain from his taxes.  If you were joint owners (example 2) you could each exclude $250,000 of gain on half the gain, effectively doubling the exclusion.  If your home is likely to sell for more than a $250,000 gain (increase in value from the purchase) then this strategy means your ex pays more tax than option 2 above.

Now back to taxes;

Probably what will happen is that your spouse is sole owner, and is fully responsible for any capital gains taxes when and if he sells the home.   Any payment to you out of his proceeds is non-taxable to you and non-deductible to him since it is a payment to equalize your assets after a divorce.

But, if he has a clever attorney and does not want to pay all the taxes, he could try and argue that you are an owner in fact even though you are not an owner in name.

You may want to seek expert assistance in that case.

[wmhall82]

Thank you. In terms of overall $ were not talking about huge sums. The original mortgage was $130k, and we divorced 2-3 years later, so the total equity at the time was maybe $50k. About 2 years later now He's likely to sell for 20-22k. If I understood our agreement correctly, i was slightly protected in that it said something about if he defaulted on the mortgage, I would have a chance to sell the property before the bank could foreclose. I came up with the plan. I know it gave my ex most of the advantages at the time, but it sounded like a good compromise that would keep my kids in their home, and pocket me some cash in the long run. He doesn't have an attorney and doubtful he will spend the money for one. He's gonna turn around and sink all his gains into a more expensive property.

[Opus 17]

" in that it said something about if he defaulted on the mortgage, I would have a chance to sell the property before the bank could foreclose"

You would have that whether you were still the owner, or a lien holder.  And frankly, the bank doesn't want to foreclose.  But the problem would be that, since your lien is secondary to the bank's lien, you have to make the bank whole first before you get anything back for yourself.  

It's fine as long as everyone does what is expected and colors within the lines.  But if that always happened, no one would ever need attorneys at all.  Good luck.