When a couple divorces, certain kinds of community property assets, such as shared bank accounts, can be straightforward to divide. If they have built up a diversified portfolio that includes one or more rental properties, however, the question of how to fairly divide those properties may be superseded by a different one—might it be in both parties’ long-term financial interest to keep the property and retain the rental income? Dividing rental income in a divorce adds another layer of complexity to the decision-making process.
Shared investment properties can be handled several different ways during a divorce, and determining the right solution for any individual situation can be highly complex. Important factors to consider are the value of the property, how much income it produces, the tax implications of selling it versus keeping it, and what expenses and tasks would be involved in continuing to own and rent out the property together. Consulting the right legal, financial, and tax professionals is essential for not only determining the best course of action but also for laying the groundwork to make continued co-ownership and management of rental properties successful.
- What Happens to Rental Properties During Property Division
- Dividing Rental Income in Divorce
- Considerations for Owning Rental Properties Together After Divorce
- Frequently Asked Questions
Considering hanging onto a shared rental property after your divorce?
What Happens to Rental Properties During Property Division
Investment rental properties are subject to division under California’s community property rules in the same way any other shared asset would be. Therefore, the first thing to be considered is if the property or properties are separate assets (owned or acquired by one partner prior to the marriage) or marital assets (acquired during the marriage).
The determination may not be quite that simple, though, if marital funds were used to pay down the mortgage on a separate rental property or for maintenance or upgrades. In these cases, the commingling of funds may give the other spouse a partial community interest in the property. Clarifying what share each spouse is entitled to is the first step.
Next, it will be necessary to get an appraisal to determine the value of the property. Knowing the worth of the property is essential for being able to accurately assess the possible advantages and disadvantages of the available options for dividing rental property and negotiating a fair settlement agreement.
In many cases, couples may opt to sell the property and simply divide the proceeds, or they may negotiate an agreement where one spouse buys out their ex’s share in the property by exchanging other assets or buying out the other spouse’s interests. In situations where they own multiple rental properties, they may work out an agreement in which each keeps properties of an equivalent value and becomes sole owner of those properties. These solutions have the advantage of completely separating their future finances.
Nevertheless, there may be circumstances under which both parties prefer to keep the rental property. The most obvious would be if the property is generating a considerable amount of income. An immediate sale may also result in a large capital gains tax bill, or the timing of the sale might not be ideal for realizing the most potential value. In these cases, the divorcing couple may wish to consider whether keeping the property and splitting the income from it is feasible. Consulting both financial and tax professionals is a prudent move to ensure that both the short-term and long-term implications are fully understood before a decision is made.
Dividing Rental Income in Divorce
As a community property state, California gives spouses equal interest in their marital property, meaning that they get an equal share of anything they both earned while they were married and anything they purchased with that money during that time. For a rental property they acquired during marriage with community property, each would own half the property and be entitled to half of the rental income. In a more complex situation, where some portion of the property is considered to be separate, dividing rental income in divorce would be proportional to each party’s ownership stake.
The Internal Revenue Service taxes rental income as regular income, so the amount of tax to be paid will depend on each party’s tax bracket. Certain expenses such as mortgage interest, property taxes, operating expenses, depreciation, and repairs can also be deducted to lower the tax burden. Those who own a partial interest in a rental property are responsible for reporting and paying taxes on their portion of the rental income and can claim deductions for their share of the expenses.
Considerations for Owning Rental Properties Together After Divorce
Despite the possible financial advantages of retaining shared rental properties, they can rapidly become a source for ongoing conflict if the details of how those properties will be managed are not carefully considered. The arrangement should be formalized with a legal agreement that details each party’s responsibilities and rights, laying out how carrying costs and expenses for upkeep will be handled and establishing a process for selling the property if either party wishes to discontinue their shared ownership. Hiring a property management company to deal with the day-to-day operations can help reduce friction and preserve a good working relationship.
Each party should also have control over statements relating to the property—bank statements, rental company statements, and other financial documentation—to ensure ongoing visibility into the property’s finances. Taking the time to work through what will be involved in co-owning a rental property with your ex-spouse, with the aid of an experienced attorney to negotiate and draft a comprehensive agreement, can help establish a shared understanding that minimizes future conflicts and makes successful co-ownership possible.
Expert Family Law Attorneys for Complex Property Division
If you’re considering whether hanging onto a shared rental property after your divorce is in your best interest, the experienced family law attorneys at Hoover Krepelka can help. Our expertise in complex property division, including dividing rental income in a divorce, gives us unparalleled insight into the potential challenges associated with equitable division of investment properties. We work closely with highly qualified financial professionals to ensure that you have all the information you need to pursue a divorce strategy that will protect your financial future. To schedule a consultation, fill out the form below today.
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Frequently Asked Questions
How is rental income from investment properties divided in a divorce?
In California, rental income from community property is typically split equally, while income from separate property stays with the owning spouse unless it is commingled.
What happens to rental properties during property division?
They can be sold with proceeds divided, one spouse may buy out the other’s share, or both may continue co-owning under an agreement. The classification as community or separate property determines how it’s handled.
Are there tax implications for dividing rental income in divorce?
Yes, transferring rental property can trigger capital gains taxes, and the receiving spouse must report post-divorce rental income as taxable.
