Dividing assets during a divorce can be complex, and investment properties add another layer of consideration. These properties, while potentially valuable, come with ongoing management needs and tax implications.
In this piece, we will explore the key factors to consider when dealing with investment properties in a divorce settlement and discuss your options for ownership and potential tax consequences. Let’s dive in.
Key Takeaways
- There are different ways investment properties are divided in divorce: selling, transferring, or retaining the assets.
- Selling an investment property during divorce can simplify financial separation but may trigger capital gains tax. Retaining joint ownership, on the other hand, poses risks for potential future conflicts.
- To obtain rollover relief, asset transfers must be under a court order compliant with the Family Law Act 1975 or a binding financial agreement following specific regulations.
Investment Property Ownership in Australia
Around one in five Australian taxpayers owns an investment property, making it a significant aspect of the Australian real estate market. The majority of these owners, around 71.48%, have just a single investment property in their portfolio., indicative of a widespread distribution of property investments across the country
The common ownership of investment properties in Australia complicates divorce cases, highlighting the need for clear-cut strategies to divide assets fairly. Understanding the specifics of property ownership, division approaches, and potential tax implications is critical.
What happens to investment properties in a divorce settlement?
When navigating the complexities of property division in a divorce, particularly with investment properties, the process can be intricate. To determine an equitable distribution, the family court may need to step in and consider various factors, such as:
- marriage duration
- financial resources
- future needs
- childcare responsibilities
This meticulous review calls for full transparency of each party’s financial documentation, including bank statements and property valuations, ensuring a fair property settlement.
Aside from family lawyers, financial advisors can also play a crucial role in this process. They help you identify and evaluate assets and liabilities correctly to ensure fairness and reasonableness of the settlement.
If no formal property settlement has occurred, retaining joint assets can also be considered. However, any income or assets acquired post-divorce may still be subject to division.
Joint Tenants vs. Tenants in Common
The type of ownership a couple holds over an investment property plays a pivotal role in how the property is dealt with during a divorce settlement. But what are these types of ownership, and what do they mean for splitting assets? Let’s dive in.
Joint Tenancy
Joint tenancy is a form of property ownership where two or more individuals hold equal ownership interests without owning specific individualised shares.
This unity in ownership extends to a principle known as the right of survivorship, where a deceased owner’s interest is immediately transferred to the surviving owners, unaffected by the deceased partner’s will.
However, divorce doesn’t automatically sever the joint tenancy. The property technically remains jointly owned even after the marriage ends.
To divide the property, the options include selling it, one partner buying out the other’s share, or potentially converting the ownership to tenants in common.
Tenants in Common
Tenants in Common, on the other hand, partners can own property together in separate shares, which can be unequal, based on each co-owner’s interest.
This form of ownership allows each tenant to independently manage, sell, or mortgage their share of the property without the need for consent from the other owners.
Upon the death of a tenant in common, their share doesn’t automatically transfer to the surviving owners. Instead, it’s passed on through their will or subjected to intestacy laws if there’s no will.
During divorce, property division is potentially simpler with this form of ownership as percentages are already established. Each partner can choose to sell their share, keep it, or negotiate a buyout with the other.
Let’s explore your options.
Option 1: Buy-out
A buy-out during a divorce settlement calls for a fair and accurate property valuation. To achieve this, it’s advisable to involve a Certified Practising Valuer accredited by the Australian Property Institute.
While some couples might agree to value their property by comparing it to house prices in the neighbourhood, this method is less accurate and may only be suitable if both parties are on good terms.
Calculating the the buyout amount
If the property is owned under joint tenancy (which is common for couples), both partners typically have a 50/50 stake. In this scenario, the buyout amount is essentially half of the property’s equity. To calculate that equity:
- First you need to determine the property’s current market value, usually through an appraisal.
- Then, subtract the outstanding mortgage balance from that value.
For instance, let’s say a jointly owned property is valued at $1 million and has a remaining mortgage of $500,000. The equity would be $500,000 ($1 million value – $500,000 mortgage). So, if one partner wants to buy out the other’s share (assuming a 50/50 stake), they would need to pay $250,000 (half of the equity).
However, things can get more nuanced. The property’s condition, current market trends, and potential adjustments for spousal maintenance can all influence the final buyout amount.
It’s also crucial to consider any tax implications that might arise from the ownership transfer.
Refinancing the mortgage is also a prevalent strategy for one spouse to obtain the necessary funds for buying out the other spouse’s share. However, the recent rise in the property market has complicated the buy-out process, as banks have tightened the criteria for obtaining additional borrowings.
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Option 2: Selling the investment property
To sell or not to sell your investment property during divorce? That is the question that weighs heavily on divorcing couples.
Selling the property offers several advantages for divorcing couples:
- Selling an investment property during a divorce severs the financial ties between the ex-spouses and it provides a clean break,
- The sale translates into immediate cash for both partners, which can be crucial for securing new housing, managing debts, or starting afresh financially
- Selling eliminates the complexities of co-managing the property, reducing stress during an already challenging time.
- There might even be tax benefits depending on the situation.
However, like all decisions, selling an investment property comes with drawbacks
- It likely triggers capital gains tax, which must be considered in the financial settlement.
- The couple might face unfavourable market conditions and receive a lower selling price.
The current state of the real estate market can significantly impact the decision to sell or retain an investment property during divorce. This is especially true considering that a significant portion of household wealth, 56.7%, is tied up in housing.
Option 3: Retaining Joint Ownership
Retaining joint ownership of an investment property after a divorce means both partners hold onto their ownership stake in the property, even though they are no longer romantically involved.
This approach can be appealing for several reasons:
- The property can continue to appreciate in value, potentially benefiting both partners in the long run. Additionally, they can keep enjoying the rental income it generates.
- Selling the property would trigger a capital gains tax event. By holding onto it, the capital gains tax liability can be deferred until the property is eventually sold.
- Both partners retain a say in how the property is managed and financed, allowing them to potentially make strategic decisions that benefit them both financially.
Risks of Retaining Joint Assets
While it may seem tempting to hold onto jointly owned assets after divorce, this decision carries significant risks and can lead to complications.
For instance, if one partner engages in risky behaviour or mismanages the jointly held asset, it can lead to asset devaluation or incurring debt in both names, adversely affecting both parties.
That’s why when considering retaining joint ownership post-divorce, factors like mutual trust, management of the property, and future financial commitments must be considered.
It’s a decision that requires careful thought, as it could have significant implications for the financial future of both parties.
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Capital Gains Tax (CGT) and Investment Properties
One of the crucial considerations in property division during divorce is the Capital Gains Tax (CGT). Transfers involving investment properties can incur CGT, generally calculated as 25% of the capital gain.
In most cases, any method of dividing an investment property during a divorce that involves selling the property will trigger a capital gains tax event. This includes:
- Selling the Property
- One Partner Buyout with Cash
Understanding capital gains tax (CGT)
The capital gain or loss on the disposal of a rental property is determined by the difference between the property’s cost base, which includes purchase price and associated costs such as legal fees and stamp duty, and the sale proceeds.
A 50% CGT discount may apply to individuals if the property has been held for at least 12 months, and for rental properties owned for more than a year, the capital gain may be further reduced by discount capital gain rules.
CGT in divorce settlements
In the context of divorce, there is no CGT obligation for asset transfers if the property was acquired before CGT was introduced on September 20, 1985, except for capital improvements made after that date.
Selling the property immediately during the divorce allows for the CGT liability to be resolved as part of the asset division.
Capital gains tax laws can be intricate and may vary depending on your specific situation. But with expert advice, you can develop a tax-effective strategy during asset division in a divorce settlement.
Rollover Relief
Marriage or relationship breakdown rollover relief is a provision that allows divorcing couples to disregard capital gains or losses from property transfers during a divorce, provided legal conditions are met.
Below are the following conditions:
- The Capital Gains Tax event must be caused by a legal separation
- This separation needs to be formalised through one of the following:
- A court order issued under the Family Law Act 1975 or a similar law in another country.
- A financial agreement binding under the Family Law Act or a corresponding law in another country.
- An arbitration award related to the breakdown of a relationship.
- A written agreement preventing a court order due to a state, territory, or foreign law.
- The CGT event triggering the rollover must have happened after December 12, 2006.
It’s important to note that private or informal agreements do not qualify for rollover relief, and if an asset transfer is not at arm’s length and differs from market value, CGT is calculated as though the transaction occurred at market value.
The rollover relief also applies to financial agreements for separating de facto couples from March 1, 2009 and was extended to same-sex couples in 2009-10 income tax year.
Seek legal help
The process of splitting property during a divorce is complex, making it essential to get expert legal advice. A family lawyer with expertise in property settlements like Clarity Lawyers can guide you through the financial and tax aspects of a divorce.
We can help you:
- Understand the details of buying out a spouse’s share in a property
- Draft a private agreement for dividing the property
- Ensure the terms you’re getting are just and legally binding
- Finalise property division with Consent Orders to avoid future financial disagreements
Mediation is another useful method that we often suggest, where an impartial mediator will assist both parties to come to an agreement on financial and parental responsibilities.
If you are in the process of divorce and you own joint investment properties with your partner, contact us immediately. We can help you get a fair share of those joint assets to help you move forward confidently. Speak with us today.
