03/06/07: Dividing Property Upon Divorce
By Benny L. Kass
Q: My wife and I are in the process of getting divorced. We have agreed that two rental properties currently in our joint name will be transferred solely into my name. I know that I can file appropriate forms at the office of the Recorder of Deeds to have the titles changed into my name, but my question is about the mortgages on the two properties.
One mortgage note holder told me that I have to refinance the balance on our mortgage in order to get my wife’s name dropped. Another loan officer told me that I would only have to pay a $200 fee and the mortgage would remain in my name.
If I have cash, should I just payoff both notes? If I refinance, should I borrow more than the outstanding balances so as to have some cash to remodel the properties?
A: I hope that you and your wife have discussed these real estate issues with your respective attorneys. If a property is transferred between divorcing spouses, and the transfer is “pursuant to the divorce”, there are certain taxable benefits involved for the spouse that is transferring the property. In your case, since you will get title to both properties, your wife will have no taxable consequences, but her basis in the property will become yours.
This means that when you ultimately sell the properties, the original purchase price plus any improvements will be your basis for tax purposes. In addition, you have probably depreciated the properties over the years, and your tax accountant should be consulted before you sell.
Although it appears that your lenders have given you conflicting statements, I do not think they did. Generally, when a couple gets divorced, and their jointly held property is transferred to one of the parties, the only way to get the spouse who gives up the property off of the mortgage obligation is to refinance the house – or pay off the existing mortgage with all cash.
So when your lender advised that you can solve the problem by paying a $200 fee, I am not sure that this will, in fact, get your wife off the mortgage. You should go back to that lender and confirm the facts.
But, since it appears that both of your mortgages carry a low balance, I would consider refinancing both properties, and pull out additional cash to use for remodeling and upgrading. The mortgage interest will be deductible for tax purposes, and any improvements you make to the houses will increase your tax basis. Of course, you never want to have the most expensive house on the block.
You indicated that you were considering paying all cash to pay off the mortgages. Obviously, that’s one alternative. Many people firmly believe that they should have no financial obligations encumbering their real estate.
While I understand this position – especially if it relates to the family home and not investment properties – I do not subscribe to this theory.
Real estate will, in my opinion, appreciate in value over time. Clearly, I don’t think that the unbelievable increases we have seen in the past two years will be repeated in the foreseeable future, and indeed real estate prices are currently in a slump. However, history has shown us that overall, real estate appreciates 3 to 5 percent on average on a yearly basis.
Thus, if you own your properties free and clear, in my opinion you are holding “dead equity”. Since your house will appreciate whether or not you have a mortgage, why not use some of the equity in the house for other purposes instead of just letting it sit in the property?
Obviously, it does not pay to borrow money at 6 plus percent and just put it in a bank account paying you only 3 percent. But you have indicated that you want to borrow additional money to upgrade your investment properties. In my opinion, that makes a lot of sense, especially in today’s market, when interest rates – even for investment properties – are relatively low. No one can predict what the rates will be by the end of this year.
The stock market is uncertain, based to a large degree on the uncertainty of the housing market. The Federal Reserve Board may change its course and once again start to increase the cost of funds – which will most likely start to impact on mortgage interest rates.
Accordingly, I cannot recommend paying off your outstanding loan balances.
Additionally, I believe that the rental market will continue to be aggressive. People still have to live somewhere, and if they are not buying, they will rent. One final bit of advice. One of your properties is in the District of Columbia. There are specific requirements in the District which landlords must follow – even if you own just one property there. You can find more information by going to the DC web site (www.dc.gov). At the home page, you will find a box entitled “what can we help you find” and type in “landlords”. This will direct you to the appropriate information you need to make sure you are legal.