You and your husband were smitten by the success of Tarek and Christina from HGTV’s Flip or Flop. You even saw how successful average people were able to do it on YouTube. Following Tarek and Christina’s lead and a strong rebound in the real estate market, you started buying houses to sell. You quit your regular jobs because you found you could earn much more in real estate. 2019 was amazing: you made over $300,000 flipping 5 houses around Metro Phoenix.
You have been buying everything you can and now have 10 houses in various states of repair and four under contract. Everything is seemingly going well until you find out your husband has been sleeping with his college girlfriend. He wants out of the marriage. Ironically enough, Tarek and Christina also filed for divorce in 2017 and it was finalized in 2018. What happens to the house flipping business?
When a married couple divorce while engaged in a joint business venture, the process of distributing assets and debts can be much more complicated than in the average marital split. Here are some factors you will have to consider.
Did you file last year’s taxes? Have you been making quarterly tax contributions in anticipation of this year’s taxes? What about capital gains on your growing pool of investment assets? Even if you have taken care of these issues, how will you and your spouse divide the tax obligations after your divorce?
You may choose to file jointly for the upcoming tax year since you were married for some of the that time, or perhaps you decide to prolong completing the divorce until after January 1 for accounting purposes. This is one area in which setting aside your (justified) feelings of resentment can be to your financial benefit because pre-dissolution planning will leave both parties better off financially after divorce.
You have four houses under contract (titled through the LLC that you and your spouse co-own and co-direct). Some of those properties were acquired with hard money loans and you and your spouse cannot afford to let the chaos of divorce stall the closing of escrow. Because not all properties are equal, it is not as simple as divvying them up one-by-one and calling it square. Triangulating with your family court attorney and your business advisor or financial planner is critical to ensure that your investments are not compromised by your changing family landscape. Also, some loan contracts contain language that treats the filing of a petition for dissolution as a default event, so your lenders may come calling sooner than you anticipated.
Dividing your checking and savings accounts is simple enough: whatever was in the accounts at the time the divorce petition was filed is usually divided in half. But what about your 401(k), your SEP IRA, or your children’s 529 College Savings Accounts? Determining how to properly divide and manage those assets is challenging in any divorce, but it can be especially difficult when a budding business venture is involved.
For example, if you and your spouse borrowed from the 529 account while the market was investor-friendly in 2019 to supercharge your investment strategy, but never paid the money back, what will you do? Again, because your investments are more complex than average, it will probably not be as simple as drawing a line down the middle of each asset and debt.
4. The Business
As alluded previously, if you and your spouse co-own and co-direct the LLC that you use for your business (or numerous LLCs, as is often the case for real estate investment ventures with separate corporate entities for each property), then you will have to decide how to proceed. Some couples are able to compartmentalize their business and continue to work together even after divorce, but others cannot and must unravel their own complicated corporate structures in order to determine the best way to divide the property without losing too much value. This becomes even more challenging if there are other investors involved: many (if not most) corporate operating agreements contain language that triggers stock buyout options or other consequences for the filing of a dissolution petition by one of the shareholders.
Imagine that you resolve the above issues (and many others that arise during your divorce), but later you are sued by a homeowner who purchased one of the properties you flipped. They allege that you misrepresented the condition of the property and that defects in the remodeling caused injuries. You and your spouse always use licensed contractors on your projects, but since you were trying to save money on some of your earlier flip properties, it’s not clear whether the damage was caused by something you did on your own. More troublingly, the contractor has since moved to California and you are left holding the bag. Your husband’s position in the civil lawsuit is that you now solely own the LLC that sold the property, leaving you with tremendous potential exposure. Can you reopen the divorce decree to have this new liability reallocated more fairly?
Obviously, the issues raised above merely scratch the surface of the concerns you should have and the decisions you will need to make. There are hundreds of family law practitioners in the Valley, but some are better situated than others to tackle complex business issues in a divorce. If you own a business and are considering divorce, you should not flip open the phone book and call the first attorney you see. Your first step should be to call around, ask questions, and find counsel who understands your business, your strategy, and your goals. For more information on community business assets and how they are distributed, click here.
Leslie A. Satterlee is a partner with Woodnick Law and has been practicing family law exclusively since graduating cum laude from ASU’s Sandra Day O’Connor College of Law.