April Fools brought us a panel decision in Smedley v. Smedley (312 EDA 2023) which takes on the issue of whether home sales or other “one time” transactions are a basis to seek modification of child support or alimony awards. It’s a great issue and one for which we could all use some guidance. Unfortunately, all we got from yesterday’s ruling is a non-precedential finding of “no error.” These are the limitations lawyers struggle with since the Superior Court reduced its role to “error correcting.”
The facts are fairly common. A pre-Covid divorce in Bucks County ended with wife getting the family homestead subject to the existing mortgage. The couple bought their home in Bensalem in 2004 for just under $700,000. We know the balance due on the mortgage was $348,000 at the time of sale and there was support for three kids paid by husband and an alimony award of $2,955 a month for 42 months. In March 2021 wife listed the house for $950,000 and sold it for that price in 72 hours. The property closed a month later at $910,000 which suggests something occurred with the sale between the agreement date and the settlement.
In the world of federal and state income tax, wife would have probably had 7% costs of sale which would have taken her $910,000 sale price down to $846,000 for tax purposes. In the divorce, the party getting the residence also gets the tax consequence and a carryover basis. Since the property was acquired for $685,000, there was, for tax purposes a $161,300 gain. It’s not clear how husband calculated wife’s gain but it appears he omitted the costs of sale when he alleged her “profit” was either $230 or $238,000 (the opinion employs both numbers). Under 26 U.S.C. 121, a single person can exclude up to $250,000 in capital gain from sale of a primary residence. Thus, no federal tax on this sale no matter which calculation you use. Pennsylvania is not so generous. They will want their 2.8%, a tax of $5,761 on my calculations (not husband’s). So, $161,300 in gain less $5,761 in state tax is a true gain of $155,539.
Take that number in 2021 and on top of her earnings, wife’s realized gain from sale of the house amounts to an additional $12,960 a month in income available for support. (161,300/12). It’s not regular income; sale of a house is a once and done transaction. But support law follows definitions of income as the IRS looks at it and under Sections 61 of the federal tax law and Section 4302 of the Pennsylvania support law, this gain is supposed to “count” for purposes of support and alimony. In a word, on these facts husband has a basis to seek a modification.
Unfortunately, the problem is more complicated than that. Income for tax purposes and income as a matter of cash can be widely divergent. The mortgage balance at sale was $348,000. If these facts are accurate, Mrs. Smedley left the settlement table with $498,000 and the need to send $5,761 to Harrisburg.
Mr. Smedley is still chafing. “You mean my ex is walking away with $500,000 and neither my alimony nor child support is affected?” Again, the answer is not simple. Mrs. Smedley got the equity in the house as part of her divorce settlement and the law is clear that we don’t count assets as income if they were part of the distributed marital estate. Otherwise, if husband got $300,000 of retirement in the divorce, why wouldn’t that count as income as well? He could access that money just as easily as wife could access her home equity.
With apologies, we propose that it’s still more complicated. This divorce was done in 2019. At that time the neighbors of the Smedleys sold their home a couple doors away for $767,000 and that house was 20% larger than Chez Smedley. So, the real estate gold rush of 2020 does appear to have made Mrs. Smedley a handsome profit that was not known or knowable when the divorce was settled. We should mention that these real estate values are not part of the April 1 ruling, but are based on comparables found on the web. Without adjusting for the difference in the sizes of the homes it appears that Mrs. Smedley made about $200,000 from her house between 2019 and her 2021 sale. Needless to say, she was not alone scoring such a profit which is what makes this case noteworthy. The trial court said it was “most important” that she replaced the $910,000 with a home of $617,000 finding that such a transaction involved “no gain.” Perhaps no taxable gain but it certainly seems that there were “gains derived from dealings in property” (23 Pa.C.S. 4302).
The trial court decided that no modification should be granted and the Superior Court affirmed. Part of the contention was that she needed to downsize for cost reasons and that she bought a $600,000 house. But was her alimony based on the cost of maintaining the big house? And if she traded down shouldn’t the alimony be adjusted, especially in a world where she did pocket a substantial gain after separation. It would seem the answer should be yes, although it doesn’t really make sense to assess those dollars in the same way as earned compensation.
This same problem arises when an executive hits the big payday, whether via stock sale or some other compensation mechanism. Let’s assume that Mr. Smedley had stock in his employer which was valued in the divorce at $200,000. Assume that while his ex was settling on the house they once owned he was selling his marital stock for $600,000. The $400,000 gain post divorce was not part of the equitable distribution, but it doesn’t make sense to count it dollar for dollar as regular income for support any more than it does to count the $200,000 increase in the home value. To do so means that children are going to live on support income of $600,000 (her 200 + his 400) and then go back to normal support the following year and then revert to normal support. That doesn’t seem to make a lot of sense. This is an issue that merits serious debate as we see more and more Americans living on gig income can be highly volatile. In the Philadelphia region, it is not uncommon to see an employee leave big pharma making $350,000 a year and take a job with a start up for $150,000 that comes with 200,000 options to buy stock in his new employer at $1.00. There is no quick answer to this but the days when everyone went to work, got paid a salary and an extra week at Christmas is not how comp works anymore. Hanrahan v. Bakker 151 A.3d 195 (2018) may have been right in holding that $52,000 a month seems a bit rich for two kids but equally absurd is the idea that a co-parent must chance spending money not yet awarded to her while she proves what he kids need beyond $4,250 a month and seeks judicial approval for those expenses.
SideNote: This case has another back door hearsay issue similar to what we saw last week. Wife introduced three blog posts from California professing to opine on how capital gains on home sales are treated for tax and support calculation purposes. These were admitted over objection because they were “relevant” and the Superior Court agreed. This may be the trial attorneys’ error if the objection was to relevance. The one post actually helped husband because it referenced the exclusion of home sale gain from income tax. But, much as bloggers are pained to admit it, our rantings are out of court statements which we profess to be for the truth of the matter asserted and had there been a hearsay objection, it merited being sustained.
For those interested in the cap gain issue, here is what Kipplinger offers: https://www.kiplinger.com/taxes/capital-gains-home-sale-exclusion
The identity of the mysterious Californian bloggers was not revealed in the opinion.
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