Edition: U.S. / Global

TALKING; Divorce Keeping Taxes Minimal

Published: September 25, 1988

THE bloating of property values in many parts of the country in the last several years is creating a new set of issues for couples to face in separation and divorce.

Lawyers and financial consultants are particularly concerned about the huge capital gains taxes that could be inadvertently incurred if the couple become so entrenched in their emotional wars that they fail to act prudently.

The warnings are being directed most strongly at couples who have been together a decade or more and who bought a home early on. Such couples may also have bought a vacation home and perhaps an investment condominium or two.

There are now thousands of these couples, according to the National Assocation of Realtors. ''When you see these cases, it makes you want to reach for the aspirin bottle,'' said Raoul Lionel Felder, a Manhattan-based matrimonial lawyer with a national practice.

The problem, the lawyers say, stems from the proliferation of feminist-inspired laws in the early 80's that require courts to abide by the legal principle of ''equitable distribution'' or ''community property'' when apportioning marital assets. To be faithful to that principle it is often necessary to require the sale of any or all of the couple's real estate holdings - if they cannot agree on a better solution themselves - since those holdings usually represent the bulk of their assets.

One or both of the partners, moreover, will usually demand a sale of at least one of their properties because ''they figure they can use the cash for all the added expenses they now face,'' said Robert Grossman, a tax lawyer in Washington. Yet unless the division is handled in a businesslike manner those sales could set off an avalanche of capital gains obligations that could severely deplete the overall value of the holdings.

''We're seeing a whole new emphasis on the tax cost,'' said Martin M. Shenkman, a New York City lawyer and accountant.

For example, if a vacation home or investment condo was bought in 1981 for $100,000 and is now worth $500,000, its sale could trigger a combined state and Federal capital gains tax of $132,000 (33 percent on a profit of $400,000).

How might this tax be reduced or even avoided? One solution, where practical, is for one of the partners to move into the vacation home or investment condo, at least for a while.

''We had a couple who had bought a rental house as an investment,'' said Bernard Rinella, immediate past chairman of the Divorce Laws and Procedures Committee of the American Bar Association and a lawyer in Chicago. ''So the way they divided things was for the wife to keep the family house and the husband to move into the rental property.'' The difference in value between the properties was made up in other ways.

By establishing residence in the rental property, the husband was able to avoid paying any capital gains tax, whenever he decided to sell, since he could now classify that property as his principal residence. The wife could enjoy a similar benefit from the marital home. This is because any capital gains tax due on the sale of a principal residence can be deferred provided the owner, or owners, buy another principal residence within two years of that sale that is equal or higher in value.

Mr. Rinella noted that there is no time requirement on how long a person must live in a property before it can be reclassified as a principal residence for tax purposes. ''But it must be bona fide,'' he warned. This would mean genuinely living there for at least six months, paying taxes and registering to vote from that address.

Should the couple find they cannot equitably divide their assets without the sale of the family house, then they should be aware that they can both avoid a tax obligation by buying separate homes whose combined values are at least as high as the family home.

THIS division does not have to be equal, Mr. Shenkman noted. Say the family house was worth $500,000. The wife needs a larger place than her husband because she is retaining custody of the children. She could buy a property worth $300,000 and he could use up the remaining $200,000 without either incurring a tax liablity.

But if the husband preferred to rent he would be liable for his part of any capital gains tax unless he used up that $200,000 within two years after the sale of the marital residence.

Tax experts disagree whether the Internal Revenue Service could demand that tax from the former wife if her former husband refused to pay the bill.

But to make sure neither one receives the other's bill, Mr. Shenkman suggests that the obligation to pay such a tax liability, should it come due, be spelled out in the separation agreement.

Mr. Felder warns couples likely to break up in the near future to keep leases on rental properties on a short-term basis, if possible, in case those properties have to be liquidated. An existing tenant with lease protection can depress a sales price and lengthen the time it takes to sell a property.

If an investment property was bought by the husband without the wife's involvement the wife should be sure to get all the documents that show how much was paid and the costs of any improvements made. Otherwise, Mr. Shenkman warned, verifying those costs for tax purposes at the time of sale can be extremely difficult. And without proof, added taxes could be incurred.

Similarly, Mr. Shenkman is concerned that some of the old-style real estate tax shelters, bought before the Tax Reform Act of 1986, might look like an ideal asset to assume. But some had a deferred pay-in period - say $10,000 a year for five years. And that could leave the acquiring spouse with more financial obligations than he or she is now able to fulfill, as well as an ''asset'' that may not have much real substance.

By contrast, the new tax laws suggest that a small rental property, such as a condo with a slight negative cash flow or strong depreciation potential, may now make sense for one spouse to take on if that spouse's single income will fall below $100,000. Deductions might now be available that were restricted when their incomes were combined.

But Mr. Felder cautions that such people are often forced to sell sooner than expected when their more limited single income, or the income from the rents, fails to generate sufficient cash to cover overhead and taxes. ''Don't rush to become a landlord on your own unless you are sure you know what you are doing,'' he said.