September 1, 2017
I received this very interesting question from a divorce attorney recently:
I have a divorce case where there is a dispute over an option to buy in the parties’ residential lease.The parties did not pay for the option to buy and the rent paid does not lower the purchase price. However, the purchase price in the option is $70,000 and the fair market value may be around $100,000. My thought is that this option has no value.
This is a very interesting – and tricky – issue. Unfortunately, there is no standard way to handle this. I wouldn’t say the option has no value, it’s just a matter of what the real value is.
The problem is that we won’t know the real value of the option until the unit is sold in the future. If indeed they get $100,000 then the option is worth $30,000. However, one could argue that there is no guarantee the holder will be able to sell the property for $100,000. He/she could get more or less than that. So, the real value of the option could be more or less.
If the unit is intended to be sold within the next 6 years, one solution would be to omit the value completely from the property division, but write into the decree that when the unit is sold they split the proceeds above $70,000. Six years is an important detail because the IRS says that transfers of property “incident to a divorce” (which means within 6 years of the divorce) are considered a non-taxable gift.
If the couple wants to settle up now, or the property is intended to be held for a longer than 6-year time period, then a value will have to be assigned to the option. In addition to coming up with a potential sale price for the unit, there are some other considerations for the holder:
• The costs of the sale (realtor fees) should be deducted from the sale price. There may also be transfer taxes or other fees that reduce the gross proceeds.
• Depending on how long the purchaser lives in the property after it is purchased, the gain when it is sold may be taxed. The owner will have to live in it for 2 years after purchase for the property to be considered a personal residence and therefore receive a tax-free gain.
If the owner doesn’t intend to sell within 6 years, or he/she doesn’t want to wait and split the proceeds as described above, I think the couple needs to discuss and come to an agreement on the following:
1. Assumed sale price of unit (something more concrete than “around $100,000”)
2. Assumed realtor fees and other closing costs
3. Clarification on how long the owner will live in the unit: if it is intended to be sold within a short time period then taxes on the gain should be deducted from the value (and the obligation to sell written into the decree.)
Many thanks to the attorney who allowed me to share this question with you. Keep the questions coming!
