Rental Properties in Divorce Settlements

Rental Properties In Divorce Settlements -Investment real estate as part of property division requires special attention. That is due to the numerous factors that affect their value:

  • Cash Flow. If the rent is covering the mortgage, repairs, management fees and property taxes, there is positive cash flow. Depreciation may shelter all or part of that cash flow for tax purposes making it of even greater value. 
  • Equity. Is the property’s value greater than its debt? 
  • Cost basis. This is extremely important with rental property for the following
  • Unlike residential real estate, there is no capital gains exclusion ($250,000 for single and $500,000 for married for personal residence). 
  • Many rental properties are acquired through 1031 (like kind) exchanges. That means the owner exchanged a previous property for the current one and any capital gain was deferred. The cost basis of the old property became the cost basis of the current one, so a large capital gain could be embedded. 
  • Depreciation recapture. When a rental property is sold, all the depreciation that has provided such nice tax deductions is recaptured and taxed at ordinary income tax rates, not capital gains rates. That can create quite a hefty tax bite. 
  • Debt forgiven on investment property does not qualify under the Mortgage Forgiveness and Debt Relief Act. Foreclosures and short sales will generate taxable income. There have been some settlement agreements in which multiple rental properties were divided strictly on the basis of equity in the properties. It is highly suggested that a more in-depth analysis should be done.

    Tax saving Idea: If the property is a house or condo and meets geographic and lifestyle needs, a spouse could move into a rental property for at least 2 years. That would qualify it as a personal residence for the capital gains exclusion upon sale. 

    Contact us for more information on divorce and rental properties.

    Information provided courtesy of Thea Glazer.  

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