Divorce and Real Estate

Divorce and Real Estate

When a marriage ends, one of the most contentious issues can be dividing up the assets—figuring out who gets what. If the spouses own real estate together, this is likely to be among the most valuable assets.

Although it can be hard to make rational decisions in an emotionally charged situation, it’s worth the effort. Making decisions out of anger or spite can be really expensive.

When divvying up ownership of the house, there are a few options. Couples can do nothing, maintaining joint ownership and putting off the disposition of the property indefinitely. Sometimes this happens when the couple plans to leave the property to their kids someday.

They can sell the property and divide the proceeds. Depending on the situation, this can be an expensive option. In a buyers’ market, when one spouse refuses to allow the other spouse to buy him or her out, a forced sale can lead to a financial loss. Even if the house has increased in value since it was purchased, there are still fees associated with the sale. If the couple has young children, a more important cost may be the emotional price the kids pay when they’re displaced from their home.

A better option for many couples is an inter-spousal transfer deed or a quitclaim deed. These allow one spouse to transfer title to the other without triggering a due-on-sale clause or a reassessment of property taxes.

While this is a good option for many, it’s important that both spouses consider the economic viability of only one person retaining ownership (and the expenses associated with home ownership) before going this route. Keep in mind, the spouse who gives up ownership remains on the loan documents. When the bank underwrote the loan, they assessed the risk based on both spouses: potentially, two incomes and the better of the two credit scores. So although the divorcing spouses may agree about who is taking on the mortgage payments in return for ownership of the property, if the spouse who receives the property defaults on the loan, the lender can come after the other spouse for compensation.

In case you’re wondering, an inter-spousal transfer deed occurs when one spouse transfers ownership to the other. A quitclaim deed is a legal document that says, in essence, “I transfer any interest I may have in this property.” Quitclaim deeds are often used to resolve disputes between neighbors. For example, if neighbors disagree about an easement involving their two properties, one neighbor can provide a quitclaim deed clarifying that he gives up any ownership of the disputed area. Interestingly, you can give someone a quitclaim deed on a property you don’t even own because there is no “title covenant” (requirement to prove you own an interest in the property).

These same transfer-of-title issues apply whether the property in question is the primary residence or income property. If the couple owns investment properties, they should consider whether both spouses have the economic capacity and business acumen to manage property. Typically, one spouse has been the investor and had tailored the properties that match his or her comfort level.

To divvy up investment properties, a portion could be sold to cash out one spouse, or other assets could be traded for equity in the property; or perhaps the non-acquiring spouse could receive a note secured by the property. When calculating who gets what, remember that the one who keeps the rental properties may have to pay legacy capital gains taxes.

As always, I highly recommend that before making any decisions like these, consult your accountant and/or attorney first.

If you have questions about real estate or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 40 years.

Before You Sell, Talk to Your Accountant

There are many compelling reasons to sell your house or other real estate you may own. Maybe you want to move closer to grandkids. Maybe you want to move further away from grandkids. Maybe you need to sell an investment property, so you can put your grandkids through college. Regardless of your motivation, here are things you should do before listing the property for sale:

  1. Select a Realtor.
  2. Ask that Realtor what do to before listing the property, because he or she may come up with something in addition to the tips in this column.
  3. Take care of minor maintenance issues.
  4. If it is your residence, remove a third of the house’s contents—from furniture to clothing.
  5. Deep clean the whole house, under every bed, behind every door. No one is comfortable with someone else’s dirt.
  6. Order inspections: pest and fungus, whole house, septic—you name it. You can provide inspection results to prospective buyers, so any offer they make is based on all available data (and they can’t come back later and use inspection results as a reason to negotiate a lower price).

That was the easy stuff.

Now, if you’re an organized person, the next part won’t be too bad. You should pull out the documents from your original purchase of the property and review them to see if there are disclosures that are still relevant. If the original seller disclosed a leak in the roof and you just replaced the roof, it’s not relevant. On the other hand, the unpermitted garage-to-game-room conversion will still require disclosure.

Next, start making lists: First make a list of work done since you’ve owned the house (like that new roof we just mentioned, any appliances you’ve replaced that are staying with the property, interior and/or exterior paint, and new drip irrigation, for example). Make a copy of your receipts for the buyer. Then, make a list of any vendor or service contracts associated with the property: pool service, burglar alarm system, landscaping, and perhaps heating/air conditioning maintenance agreements. If you have a commercial building with an elevator, it likely has a service contract, too. The buyer may be obligated to continue some of the contracts; other vendor information will simply be a courtesy.

By the way, it can be useful to show utility bills before and after you install new insulation or upgrade windows. Buyers love that stuff!

Depending on the type of property to be sold, you may consider scheduling an appointment with your attorney, accountant or perhaps an estate planner to avoid opening a can of legal worms. Please do this before putting the property up for sale for your own sake, and that of your Realtor and buyer. Among other things, a good tax advisor will help you do the math to avoid a nasty problem called “loan over basis” from capital gains tax.

Each transaction is unique and a good tax accountant will consider all the variables important to your situation. However, unless you have extenuating circumstances, you’ll likely pay about a third of the gains from your sale in taxes. Bear in mind, your gain is calculated without regard to the amount you owe on the property. In very simplistic terms, it is the sales price minus the cost of the sale minus your acquisition cost minus improvements plus depreciation.

Again, notice the amount you owe was not included, so your taxable gain could be $200,000 resulting in a tax liability of $65,000 and the property might only generate $50,000 in cash after sales costs and loan payoff. This is a common problem with investment properties, and one your tax accountant will be familiar with, which is why I say again: talk to your tax accountant when selling real estate.

If you have questions about real estate or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 40 years.

 

 

How are 1031 Exchanges like musical chairs?

If you’re interested in investing, 1031 Exchanges are a wonderful, legal way to defer tax liability almost indefinitely. Sound good? Read on.

As always, when I write about investing or tax implications of owning real estate, I am simply sharing my opinion. If you are thinking of investing or have questions about taxes with regard to real estate, speak with your financial advisor and/or tax accountant.

The basics of a 1031 Exchange are simply this: you trade the equity (amount you own free and clear) in your property for the equity in a new property. Basic enough? Although it sounds simple, it can get pretty complicated.

To defer taxes, you need to exchange your current property for a property of equal or greater value.  To the extent that you get cash out or reduce the amount you owe (called boot), you will have to pay capital gains taxes. Capital gains taxes are approximately 10-15 percent lower than income taxes, so that’s good, but if you want to defer all your tax liability, you need to trade properties with equal or greater equity and equal or greater debt.

So, what’s the benefit? Well, if you find someone who owns a property you’d prefer, and they prefer your property–and the properties have equal values and equal debt–you are allowed to trade without paying any taxes.

In recent years, a new chapter was added to the 1031 Exchange rulebook: the Starker Exchange. Prior to Starker, you had to either find someone who wanted your property or a number of individuals who all wanted to trade like properties. Think musical chairs except there are enough chairs for everyone: one, two, three, SWITCH.

In the post Starker world, you list a property for sale and sell it to an exchange accommodator, a middle man. The accommodator takes title to the property and sells it to a third party. The accommodator holds all the cash, kind of like an escrow account. You find a property you’d like to own and the accommodator buys it using your money. He or she then transfers the property to you to complete the exchange. You end up with a more desirable property and pay no taxes.

The clock is ticking on these transactions. After selling your property, you must identify the exchange property within 45 days and complete the purchase of the exchange property within 180 days or by the end of the tax year. However, the 1031 Exchange doesn’t have to be a one for one in terms of numbers of properties, just amount of equity and debt.

Let’s say you own an apartment complex. That’s a big investment, and therefore harder to sell than a single-family home. You could use a 1031 Exchange to trade your apartment complex for several single-family homes. Then, if you only need to liquidate (sell for cash) one of the homes, you only pay capital gains taxes on a single-family home, rather than on the value of the whole apartment complex.

The downside of 1031 Exchanges are these: 1. Accommodators charge a fee for their service. It’s a reasonable fee, but it’s a fee. 2. The income tax basis of your original property is carried to the new property. This means lower depreciation for the future, and when the property is ultimately liquidated, the capital gains will be increased by the amount deferred in the first transaction.

Income tax basis is the amount paid for the property plus capital improvements minus depreciation. The real benefit of a 1031 Exchange is that you basically get an interest-free loan from the Internal Revenue Service and State of California — you have more equity to invest in your next property because you’re not paying taxes on each transaction. As long as you have a long-term view of investing, 1031 Exchanges can be a great way to go.

This is a very simplistic summary of a very complex topic. You must have good real estate advice as well as a tax professional to work with you.

Next time I’ll write about disclosures – where there really is no such thing as TMI (too much information). If there’s something you would like me to write about or if you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.

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