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What Happens to Rental Properties in High-Asset Divorces?

Divorce can be a complex and emotionally charged process, especially when it involves the division of significant assets. Among these assets, real estate holds particular importance due to its substantial value and the complexity of its division. Rental properties, distinct from primary residences or vacation homes, often pose unique challenges in high-asset divorces. 

If you’re preparing for a divorce and you own California rental properties, you need to understand how they may be divided in your split. Let’s break down how rental properties are treated in divorce proceedings and the methods for dividing these assets effectively.

The Unique Nature of Rental Properties in Divorce

Rental properties in divorce differ significantly from other types of real estate, like primary residences or vacation homes. The primary distinction lies in their function as income-generating assets. Unlike a primary residence, which is valued primarily for personal use and emotional attachment, or vacation homes that may be used sporadically for leisure, rental homes are investments with tangible income streams and tax implications.

The valuation of rentals must consider not only the current market value but also the revenue they generate, their operating expenses, and their future income potential. These factors make the appraisal of rental units more complex and can lead to disputes over their true value.

Legal Considerations for Dividing Rental Properties

In high-asset divorces, where multiple properties and substantial financial interests are involved, the division of rental properties requires careful legal consideration. 

In California, any assets acquired during the marriage are considered community property and must be divided equally in a divorce. This includes rentals bought or paid for with earnings during the marriage. However, suppose one spouse owned a rental property before the marriage or acquired it through inheritance or gift. In that case, it might be considered separate property and not subject to division unless it was commingled with marital assets.

That’s why the first step in dividing rentals is to establish whether they are marital or separate property:

  • Marital Property: Real estate acquired during the marriage are typically considered community property.
  • Separate Property: Properties owned before the marriage or received as a gift or inheritance are usually separate property. However, if the rental income was reinvested into marital property or both spouses contributed to the maintenance and improvement of the property, it could be partially or fully transmuted into community property.

Only marital assets need to be divided in a divorce, so determining the property’s status is essential before moving forward. 

Valuation of Rental Homes

Once a property has been identified as a marital asset, it becomes necessary to appraise its value accurately. Accurate valuation is crucial and more complex for rental units than for other types of real estate due to their income-generating potential. The valuation process will consider not only the market value but also:

  • Income statements and profitability
  • Expenses associated with maintaining the property
  • Potential for future income and appreciation
  • Depreciation and tax implications

A professional real estate appraiser is often required to assess these factors and provide a fair market value.

Strategies for Dividing Rental Homes

Dividing rental units in a high-asset divorce can be approached in several ways, depending on the circumstances of the marriage and the properties involved:

  1. Co-ownership: Sometimes, ex-spouses may choose to continue co-owning the rental property post-divorce. This arrangement requires a high level of cooperation and is typically selected if the property is generating significant income that neither party wants to disrupt. Co-ownership agreements must clearly outline responsibilities regarding expenses, profits, management decisions, and conditions under which the property may eventually be sold.
  2. Buyout: One spouse may opt to buy out the other’s interest in the property. This is often preferred when one party wishes to keep the property as part of their investment portfolio. The buyout price would be based on the location’s appraised value and could involve refinancing the property to provide liquidity for the buyout.
  3. Sale and Division of Proceeds: If neither spouse wants to maintain ownership or if liquidating the asset is more financially sensible, the location can be sold. The proceeds from the sale would then be divided according to the divorce agreement, which might consider other aspects of the asset division in the divorce.
  4. Offset with Other Assets: In some cases, one spouse might retain ownership of rental properties while the other receives equivalent value through different assets. This might include retirement accounts, other real estate, or valuable personal property.
  5. Creating a Trust or Holding Company: In particularly complex situations, especially those involving multiple properties or commercial interests, it might be advantageous to transfer property ownership into a trust or a holding company that both parties own. This can simplify management and provide a structured framework for profit-sharing and decision-making. Still, it is more complex to set up and might require ongoing legal and accounting services.

Given the complexities involved in dividing rental units in California, it’s advisable to seek both legal and financial advice. A divorce attorney with experience in high-asset cases can provide necessary legal guidance, while a financial advisor or a CPA can offer insights into the financial and tax aspects.

Protect Your Rental Properties During Your Divorce

Dividing rental properties in high-asset divorces requires careful consideration of legal, financial, and personal factors. Each method of division presents its own set of challenges and opportunities. For individuals going through a divorce that involves such assets, it is crucial to work with divorce attorneys who specialize in high-asset divorces and understand the complexities of real estate investments. With the right legal guidance, both parties can reach a settlement that respects their financial interests and paves the way for a stable post-divorce future.

If you’re in this stressful situation, the experienced divorce attorneys at Kaspar & Lugay, LLP, can help. We specialize in high-asset divorces and have substantial expertise in financially complex asset divisions. We encourage you to schedule a consultation with our Marin County divorce law firm today to learn more about how we can help you protect your rental properties during and after your split.