Going through a divorce can be a very stressful and life-changing time. There are many aspects individuals must consider when a rental property is involved in a divorce. We are here to guide you through some of those considerations.
The initial questions that must be answered include:
- Does the property currently have tenants? How long is the term of the lease?
- What is the annual cash flow of the property?
- Is the property in need of repairs or improvements?
- Does one party want to keep the property? Will they rent it out?
- How is the property titled?
- Is there a mortgage for the property? How is the mortgage titled? How much payment remains before the mortgage is paid off?
- Is the property suitable for one spouse to move into as their home?
- Does one or both spouses want to sell the property?
- Were there any non-marital l funds used to purchase or improve the property?
If the Property is Currently Rented
One option for the parties to consider if the property has positive cash flow (income) is to continue maintaining the property as rental property until the tenant’s lease expires. The income may be split or may be given to the spouse with lower income. This is an effective way to increase cash flow. After the lease has expired, parties may wish to continue splitting the income from the rental property or choose to sell or move into the property.
Buyout of Equity of the Other Party
What happens if one party wants to own the property individually? A buyout is an option that may be considered, including possible sources of funds available for the buyout and current or deferred payments to the other spouse. Other considerations include the following: (1) the equity of the home may be offset with another asset, (2) the title of the home may have to be transferred, and (3) the mortgage may need to be refinanced at a higher monthly cost.
Does the Property Have a Mortgage?
Most cases involve properties with mortgages. When it comes to the mortgage, it is important to keep in mind the remaining balance on the mortgage. In some cases, the mortgage may be assumable by one party. This will depend on the lender and the terms of the mortgage. Is the remaining mortgage an amount that can be paid off during asset division? Would the mortgage need to be refinanced or would the other party remain on the mortgage? In any path the parties choose, it is important to consider that the interest rate may increase and thus make the monthly payment too expensive for one party to pay individually. If refinanced, it would require a credit score check and ultimately lender approval.
If the Property is Suitable for One Spouse to Move Into As Their Home
Another option for the rental property is for one spouse to move into the house as their home. Some of the benefits of this option are that 1) the parties already own the home, 2) they may not need to refinance or obtain a new mortgage and 3) they may avoid capital gains tax on a sale if the spouse makes it their primary residence for at least two years. While this option may involve conversations regarding expiration of a tenant’s lease, mortgage payments and the value of the home, it may be an easier solution compared to the option of selling the property or having to buy a new home.
Sell the Property
Parties may decide to sell the property after they have dealt with the possible tenants and mortgage. During this process the homeowners would generally meet with an agreed-upon real estate agent to give them a listing price or an estimate of a realistic sales range. If there is deferred maintenance, they may also opt to meet with an experienced home inspector to assess what work needs to be done to ready the house for sale. To determine the net cash proceeds, sales costs, capital gains tax, any depreciation recapture and any rental loss carry forwards would be considered. This would help the parties understand the underlying asset value of the property.
What Happens if the Rental Property was Bought or Improved With Nonmarital Assets?
Non-marital assets include any assets acquired outside the marriage. This is important to consider when discussing options regarding what will happen with the rental property. Nonmarital assets may include premarital, gifted or inherited assets. If nonmarital assets were used toward the purchase or improvements to the rental property, there would be a non-marital component to the equity of the property. The parties may decide to trace the sources of funds used toward the home to determine the amount of marital and nonmarital equity in the house.
Divorce is often a challenging and confusing period. We are here to help guide you to make educated and informed decisions and understand the possibilities while evaluating options. Having a clear understanding of different factors to consider when a rental property is involved in a divorce is crucial to reach a fair and equitable division of the assets.
Please contact the Divorce Financial Planning team via our online contact form for more information.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.