Some couples own property that they rent out. If they divorce, they can decide to continue to own it jointly, sell it or have one spouse assume ownership. In the divorce process, there is usually a need to establish a value for the rental property to assist in this decision-making.
Which would you rather have: a rental property with a mortgage balance of $300,000 that could be sold for $400,000 or one with a mortgage balance of $200,000 that could be sold for $250,000? Probably the first one. But what if the second one generates net annual rental income (after expenses) of $10,000 per year and the first one has a net negative annual rental income of $1,000. Now the second property is looking a lot more attractive.
Rental Property Financial Benefits
There are potentially three main financial benefits to owning rental property:
- Capital appreciation (hopefully the property value will go up);
- Income generation (if rental income exceeds rental expenses); and
- Tax benefits
The tax benefits arise mainly from the fact that the IRS lets you depreciate rental property and claim a “depreciation expense” on your taxes. Let’s say a rental property generates an annual net spendable income of $5,000 and has an annual allowed depreciation expense (that requires no out-of-pocket expenditure) of $6,000. Even though in your pocket you have the $5,000, on your tax return the property can show a “loss” of $1,000 ($5,000 minus $6,000). Since you can deduct the loss, the property actually can reduce the income taxes you have to pay.
Note, however, that there are also some significant tax “gotchas” with respect to rental property. These come into play when the rental property is sold – which sometimes happens as part of a divorce settlement.
Valuing Rental Property
There is not one “right way” to value rental property. But it is a good idea to consider or find out:
- How much cash would the property generate if sold (after selling expenses and the mortgage is paid off)?
- What would be the tax bill if the property is sold?
- Is the market for similar properties in your area likely to go up or down over the time frame that is relevant for you? What is the likely risk vs. reward in this regard?
- What is monthly positive or negative cash flow from the property now and how might this be expected to change in the future?
- What is the risk of a vacancy and would you be able to absorb the costs of the property during the vacancy?
- What is the annual income-tax effect of owning the property?
Armed with this information, you can take a comprehensive view of each property and decide what you want to do. For large multi-unit rental properties and perhaps for some of the information above, you may want to use the services of a real estate professional.