POTENTIAL TAX RISKS FOR DIVORCED SPOUSES
The Housing Assistance Tax Act’s provisions on non-qualified use periods introduce significant tax
risks for divorced spouses transitioning rental properties into primary residences. Key risks include:
Increased Capital Gains Tax Liability: Due to the non-qualified use period, a substantial portion of
the gain from the property sale may be subject to capital gains tax.
1.
Depreciation Recapture: Depreciation deductions taken during the rental period must be
recaptured and taxed as ordinary income, increasing tax liability.
2.
Complexity in Tax Planning: Accurately calculating the non-qualified use period and the
corresponding taxable gain requires careful record-keeping and tax planning.
3.
Impact on Divorce Settlements: The potential tax liability associated with the sale of converted
properties should be considered in divorce settlements to ensure equitable distribution of assets and
liabilities.
4.
Tax Rate Variability: Capital gains tax rates may vary based on the taxpayer’s income level,
potentially leading to higher tax liabilities for higher-income individuals.
5.
08 DIVORCE REAL ESTATE & MORTGAGE JOURNAL
Divorced spouses can employ several strategies to mitigate the tax risks associated with converting
rental properties into primary residences:
Tax Planning and Advice: Engaging a qualified tax advisor to navigate the complexities of capital
gains tax rules and develop a strategic plan for property disposition.
1.
Use of 1031 Exchanges: Consider utilizing a 1031 exchange to defer capital gains tax by reinvesting
the proceeds from the sale into a like-kind property. However, this option has specific
requirements and may not always be applicable.
2.
Timing of Sale: Carefully timing the sale of the property to maximize the use of the capital gains
exclusion and minimize the impact of the non-qualified use period.
3.
Consideration of Deferred Maintenance: Investing in deferred maintenance and property
improvements may increase the property’s value, potentially offsetting some of the capital gains
tax liability.
4.
Comprehensive Divorce Settlements: Including provisions in divorce settlements to address
potential tax liabilities and ensure fair distribution of assets and liabilities.
5.
STRATEGIES TO MITIGAGE TAX RISKS