Sharing Home Equity:
A Win-Win Proposition?
by Ray A. Smith
From The Wall Street Journal Online
Share the wealth.
Through shared-equity agreements, individual real-estate investors can do just that to help a family member or friend buy a home -- and reap some profit and tax benefits in the process.
Some accountants and financial advisers are recommending that their clients, especially those with adult children, consider these investment vehicles as home prices have skyrocketed.
The pacts are co-ownership agreements between two parties, an investor-owner and an occupier-owner. The investor-owner puts up cash for either some or all of the down payment for a house that a family member or friend wants to buy. Once the property is purchased, both parties have an ownership interest in the property.
The family member or friend becomes the property's occupier-owner. For tax reasons, under the Internal Revenue Code (Section 280A), the investor-owner must charge the occupier-owner fair rent for the right to occupy the property if he or she wants to take any tax deductions related to the property. The investor-owner can then use that rent to cover the expenses, including mortgage payments, homeowners insurance, and property taxes.
"I almost always recommend that the investor-owner charge rents so [he or she] can maximize tax benefits," says Brian Collins, an attorney in Ross, Calif.
The agreement has a finite life, often varying from three to 10 years, after which the occupier-owner can buy the investor-owner out or vice versa; the property can be sold with the proceeds being divided between the parties; or the term can be extended.
These agreements can be advantageous for both parties. For instance, if the property is sold at the end of the deal's term, the investor-owner gets back the original down payment plus a share of the proceeds from the sale. Also, the investor-owner can get a tax write-off on expenses and could receive tax deductions for depreciation.
Owner-occupiers can benefit by deducting mortgage-interest payments and property taxes on their income-tax returns. What's more, if and when the property is sold, they qualify for exemption from capital gains -- as much as $250,000 for individuals and $500,000 for couples, as long as they lived in the property for at least two out of the previous five years.
There are some risks, though. For one, the occupier-owner might fall behind in payments and even default on the mortgage, which could force the investor-owner to foreclose on the property -- a lengthy and costly process. The investor-owner would have to pay out of pocket for the foreclosure process.
In some cases, there's also the possibility of the property depreciating so the investor-owner either would get less or just the down payment back. In addition, the occupier-owner also could neglect upkeep of the property, which means it wouldn't be attractive to a buyer when the agreement ends.
Sandra West, a Frederick, Md.-based certified public accountant, points out that it's important for investors to consult with a real-estate attorney familiar with the jurisdiction in which they're investing. "Each state has different rules regarding real-estate titling," she says. The names of all participants in the agreements must be on the property title.
Email your comments to rjeditor@dowjones.com.
