Sometimes divorcing couples co-own a house after a divorce so that their children may live there until they are older. In this routine, the parents normally agree to sell the house when the children reach a certain age.
There are pros and cons to former spouses owning the family house after a divorce.
When the custodial parent cannot afford to buyout the other parent right away the obvious advantage is that the kids get to stay in the house anyway. A deferred sale can sometimes make a buyout possible by spreading payments over time.
However, because both spouses are responsible for paying the entire mortgage, a credit report for either of them shows the entire amount of the mortgage. A large debt on a credit record, especially when one does not live in the house, makes it difficult to get credit. A failure to make mortgage payments shows up on the credit report of both parents as well.
In addition, the couples must decide how to allocate the mortgage and upkeep expenses and who benefits from the mortgage interest deduction. For example, even if both pay equal amounts toward the monthly mortgage, they can agree that one spouse takes the entire mortgage interest deduction, in exchange for some other financial compensation.
Co-ownership also means continued – and perhaps unwanted – involvement with each other.
There is also the additional risk that the nonresident spouse might have a change of heart later and want (or need) to sell sooner than anticipated, so the settlement agreement should set a specific time that the house can be sold.
If former spouses own the house together for a significant period of time after the divorce becomes final, they also risk losing the important tax benefit of IRS §1041, which is the rule that says transfers between spouses as a result of a divorce are not taxable. §1041 applies as long as the transfer takes place within a year of the divorce becoming final, or as long as it’s “related to the ending of your marriage,” which means it’s made under a written agreement or order and occurs within six years of the of the divorce. Therefore, the agreement to keep the house should be a part of the written settlement agreement, with court approval so that it becomes a court order.
The former spouses should also make contingency plans covering death while they are still co-owners. Each former spouse has the right to leave his or her share at death. If they have agreed that one of them stays in the house until the kids are a certain age, they could also agree that during that period each leaves his or her share of the house to the other, so that the resident spouse can continue to stay as planned.