While there is so much to sort through in a divorce, splitting up rental properties can add additional complexity to your separation. You do have several options for handling rental assets, and the option you choose will depend on your long-term financial goals. In this post, we help you determine whether your rental properties are marital or separate property, what to consider as you weigh the options to handle these investments and the tax implications of your decision.
Is my rental marital or separate property?
In general, rental properties that were purchased during your marriage are marital assets. If the property was purchased by one party prior to your marriage, then that property would belong to the original purchaser if the title of the property has been kept in their single name. However, any appreciation of a rental property that happened during your marriage is considered a marital value, even if one party owned it first. Learn more about marital versus separate property in detail in our related blog post.
What options do I have to handle my rental investment?
In general, you have four options when it comes to what you can do with your rental property in your divorce.
- Sell the Property: In the simplest and more common approach, neither of you keep the rental properties and instead, you sell them and split the profits net of fees and expenses, including applicable taxes.
2. One Spouse Keeps the Property: Another common approach is splitting up the properties as you would any other shared asset. In this case, one party gets the rental property and the other party gets an equal asset. Sometimes one party even moves into the rental home as their primary residence, depending on the condition and location of the property. You start this process by getting an appraisal to ensure the declared value is fair. Once this is agreed upon, the party keeping the property will need to refinance the rental in his or her name only. It is important to note that the party keeping the rental will need to be able to qualify for the loan on their own, without the spouse as a co-borrower. Therefore, mortgage planning is incredibly important prior to finalizing a divorce and a scenario that the team at A.M. Financial can help walk you through with an experienced divorce mortgage lender.
- Operate the rental properties together: A less common scenario is to co-manage your rental properties. This is not recommended in most situations but can be done, especially if you have an amicable separation. Sometimes parties choose this as a short-term solution until the market is favorable to sell. If you do choose this option, be sure to open an LLC or trust to hold the property and hire a property management company to manage the details so you don’t have to interact regularly with your ex-spouse.
- Split multiple properties evenly: If you own more than one rental property, you can both remain rental owners by equally spitting the properties. Once again, you would need to start this process with property appraisals to ensure the declared value is fair and you’ll need to have the means to refinance any properties in your name only. Therefore, you’ll need to ensure you can qualify for the loans you will need on your own.
What are the tax implications of rental properties?
Part of the financial preparation for a divorce is understanding the tax implications of your decisions around dividing assets. This is especially true for selling and/or transferring property as real estate is often the largest asset and carries the most tax liability or tax benefit. Taxes can vary based on your personal situation. Here are some tax considerations related to rental properties to keep in mind as you weigh the pros and cons of the various options above:
- Note that the personal residence tax exclusions of $250,000 for single tax filers or $500,000 for married filers do not apply to sold rental properties (unless certain requirements are met).
- Consider capital gains tax (which can be 15-20%) in addition to depreciation recapture (25%). These combined fees can reduce your profit received in a sale by upwards of 50%.
Taxes can drastically affect the total net value received from proceeds received today or in the future. Ensure you understand the current and future implications of your decisions, which vary from asset to asset. When you work with a financial advisor who specializes in divorce, you work with an expert who can analyze the pros and cons of any decision related to rental properties, in the context of your entire asset portfolio. This analysis can inform your decisions, and help you clearly understand the tax-adjusted value of your assets when dividing all marital property.
While this post addressed rental properties, many of the same concepts may apply to vacation homes or other second homes. Working with a Certified Financial Divorce Analyst (CFDA) helps you model various scenarios to ensure you are making the right decision based on your financial goals, giving you peace of mind and taking some of the emotion out of these difficult choices. When you work with a financial specialist who knows the unique implications and considerations of a divorce, you are more likely to have positive financial outcomes both now and in the future. Contact us for a consultation.