Dividing Investment Property: Who Gets the Real Estate Investment Property in a Divorce?

In a high-net-worth divorce, dividing investment property may become one of the biggest bones of contention during negotiations over asset division. Unlike other types of assets, commercial or residential properties tend to more reliably appreciate in value, as well as providing an ongoing source of income. Thus, both members of the couple may be loath to give up their share of such assets when it comes time to divide marital property.

Deciding who ultimately gets to keep an investment property is almost invariably a complicated issue. How to determine what each party is entitled to, as well as the long-term financial implications of retaining an investment property, requires the assistance not only of legal counsel experienced in complex asset division, but also of knowledgeable financial professionals who can provide key information to determine what would best protect your long-term financial interests. Here’s what you’ll learn about dividing investment property during a divorce.

• Property Division: Marital versus Separate Property
• Knowing the Value of Property for Asset Division
• Additional Considerations for Division of Investment Properties

Dividing Investment Property: Marital versus Separate Property

The first issue to determine is whether an investment property is marital property or separate property. Because California is a community property state, anything a couple earns while they are married up to the date of their separation, as well as what they bought with that money, is considered to belong equally to both. Property that was owned by one spouse prior to the marriage, as well as assets they receive individually as a gift or as an inheritance, are considered separate property. Separate property is not subject to division in a divorce. While this may seem like a clear distinction, the picture can rapidly become far more complicated depending on how a couple commingled marital and separate assets during their marriage.

For example, an inherited investment property would, at first glance, be considered separate property that would go to the spouse who originally received it. However, the couple may have taken action during the marriage that would transmute it (or a portion of its value) into marital property. This could include adding the spouse’s name to the title or using shared assets for property upkeep or to make mortgage payments. If any investment properties are not unquestionably marital property, the services of a forensic accountant may be necessary to establish that a particular investment property is properly characterized as separate or the extent to which the other spouse has acquired an ownership interest in it during the marriage.

Knowing the Value of Property for Asset Division

Assessing the value of an investment property is more complicated than making a similar calculation for a shared marital home or even a vacation home that a couple owns for personal use. In the latter cases, the equity to be divided is generally the fair market value of the property minus any mortgage or other debt against the property. For an investment property, however, additional information must be considered because the asset generates income and therefore has value aside from what might be realized if the property is sold and the proceeds split.

A professional appraiser may use different types of valuation methods for investment properties to help provide a full picture of the asset’s worth, such as calculating cash flow, net operating income (NOI), or gross income. It is essential to consult with financial professionals who can produce an accurate valuation, as this provides the basis upon which the attorneys on each side can negotiate fair asset division for these properties.

Additional Considerations for Division of Investment Properties

When dividing investment property in a divorce, there are additional factors that should be taken into account when deciding what outcome would be in your best interest. One of the first is to consider what type of properties are at issue. Residential real estate investing has different risks and potential rewards than investing in commercial real estate.

For instance, while commercial leases tend to be longer-term and may put the responsibility for taxes, insurance, and maintenance costs on the tenant, such properties can be much more vulnerable to economic downturns, leaving the owner with expensive vacancies. A residential property tends to put more responsibility on the landlord, but demand is often more stable, making the returns lower risk and more consistent. Whether these are appropriate investments that can be successfully managed going forward is a highly individual determination.

Another issue to consider is the potential tax implications of owning, and perhaps later selling, an investment property. Transfers of property under U.S. Code § 1041 do not recognize gain or loss when they are incident to a divorce, making most such transfers nontaxable. The spouse receiving the asset also receives its carryover basis, so it is important to know the cost basis of the property to be able to estimate the capital gains tax liability on a future sale. If the couple’s investment portfolio includes multi-state properties, there may be additional tax considerations and reporting requirements to consider. Consulting a knowledgeable tax advisor prior to finalizing the divorce settlement can help ensure you have considered all potential tax consequences and are not hit with an unexpected tax bill.

While issues of property division are often clouded by emotion, especially when a divorce is acrimonious, decisions of what to do with a shared investment property or portfolio of properties should be guided by facts. Experienced legal and financial guidance can help clarify the best course of action, whether that means selling the property, dividing the portfolio equitably between spouses, or one spouse buying the other out of their ownership interest.

Navigating Complex Asset Division in Divorce

How marital property is divided in divorce sets the stage for each spouse’s financial future. When shared assets are complex, such as when a couple owns investment property, the danger grows that inaccurate valuations or an incomplete understanding of potential costs and risks could result in an unfair settlement that leaves one party at a permanent financial disadvantage. The family law attorneys at Hoover Krepelka have extensive experience in handling divorces involving complex property division and are familiar with the challenges that can arise. We routinely work with highly qualified financial professionals to ensure that our clients and we have the information necessary to create a divorce strategy aligned with their best interests. To schedule a consultation, fill out the form below today.