Often in dividing the marital assets, the parties do not consider the tax basis of the asset. The parties look at the present value of the asset and divide the asset according to the present value minus any debt. However, upon closer scrutiny, the parties should at least take into consideration the tax basis of the asset. The key assets of a marriage are normally the house and pensions. We will assume that the house was purchased during marriage.
So, if one spouse is receiving the house, he/she should analyze the tax basis, not just the net equity i.e., the value minus the mortgage. This includes the years of depreciation taken on the house, as well as costs associated with home improvements and/or maintenance.
Sometimes a couple has acquired rental properties (a business) during the marriage. The tax code allows the owners of rental property to depreciate the cost of the purchase price and improvements over several years. Depreciation commences as soon as the property is placed in service or available to use as a rental. Under the tax code, most U.S. residential rental property is depreciated at a rate of 3.636% each year for 27.5 years. Depreciation is in addition to normal rental property expenses which can be deducted from the rental income in the year the money is spent.
Depreciation is a valuable tool if you invest in rental properties as it allows you to reduce each year’s tax bill. The IRS allows the owner to spread out the cost of buying the property over decades. Unfortunately, if you depreciate property, then sell it for more than its depreciated value, you’ll owe tax on that gain through the depreciation recapture tax, which is the gain realized by the sale price of the property that must be reported as ordinary income. It is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus “recaptured” as ordinary income for tax purposes.
Finally, if part of your divorce negotiations means you will receive the family residence or rental property, consult with your tax accountant. Factor in your future tax liability in the negotiations. Be prepared if the family court judge does not take this issue into account in dividing up the assets. The tax liability of the property which is not being sold in the immediate future.
