How can I make this lopsided home purchase fair?

April 6, 2010 6:31 PM

What would be a fair way for my dad and I to buy a rental property, if he is providing the down payment?

My dad is thinking about buying a house to rent out. He also would like my wife and I to be the tenants as he's had some bad renters in the past. Because of this, I was thinking it'd be a good idea for tax and investment purposes for us to be part owners of the house. My father would be providing the entire down payment. And, let's assume that the rest of the expenses (taxes, insurance, maintenance) would be split 50/50, the down payment is 20%, and the mortgage is $300k. Also, let's say that we would be tenants for 2-3 years before moving out.

So, my question is: What would a fair setup for this kinda of deal? My guess is one of the following:

1) Pretend it was an 80/20 type loan situation and make payments directly to my dad for the half of the down payment he "loaned" to me.

2) Give my dad a larger percentage of the ownership. So, 60/40 vs. 50/50

My wife and are thinking of relocating to another state, so any answers should take into account that real renters will move in eventually.

Obviously, we'll run this by our CPA to get the story on taxes. Also, we'll figure out the details about what happens if one of us stops paying and all that stuff. Right now I'm trying to come up with a setup that's pretty fair to both parties.

posted by sideshow to work & money (8 answers total)

How's your relationship with your father? Do you want to risk lifelong acrimony between the two parties if either side reneges on the deal?

Some families can do business together. Others can't.

Be very certain that yours is one of the ones that can.
posted by dfriedman at 6:32 PM on April 6, 2010

I have some ideas on a few ways you could do this (my family is involved in a variety of similar intra-family real estate arrangements), but I need a little more information:

Is he doing this primarily as an investment or primarily to help you out?

How long is he planning to keep it and rent it out after you move out? For a long time, or just long enough for it to appreciate and then he'll sell it for a profit?
posted by Jacqueline at 6:41 PM on April 6, 2010

Probably the easiest is to say that you and your dad own the house 50/50 in all gains and losses, minus the 20,000 he put in. This only works if you share in all expenses equally. So, if at the end of the 3 years you and your dad decide to sell, and it sells for $315,000, you guys will get a check for $75,000. Dad gets his $60,000 (20%) back and you split the remaining $15,000.

But really, if the deal is for just three years, just pay rent. You lose almost nothing in dollars, and the math will kill you all otherwise.
posted by gjc at 6:50 PM on April 6, 2010

You should also know that most lenders require at least 25% down on rental (or 'investment') properties, and often require 30%. It sounds like your dad might already know that. but fyi.
posted by dbmcd at 7:00 PM on April 6, 2010

How's your relationship with your father? Do you want to risk lifelong acrimony between the two parties if either side reneges on the deal?

Yeah, this is something I have to take into consideration. But, the original plan was for him to buy the house and rent it out. So, if I lost my job or something and couldn't pay, my father could (and was going to) afford to take care of it on his own. But, I know what you mean about going to into business with family and I'll need to weigh that part of the deal carefully. And I could afford to take over if the reverse happened. Although that is less likely.

Is he doing this primarily as an investment or primarily to help you out?

Mostly investment, but also to help us out. He was planning on buying the rental anyway, but this could be a opportunity to help his son and daughter-in-law.

How long is he planning to keep it and rent it out after you move out? For a long time, or just long enough for it to appreciate and then he'll sell it for a profit?

I'm thinking this would be long term, so a sale would happen far in the future. Also, so, we'd keep the same arrangement after we moved out and new renters moved in.

You should also know that most lenders require at least 25% down on rental (or 'investment') properties, and often require 30%. It sounds like your dad might already know that. but fyi.

Good to know, thanks.
posted by sideshow at 7:24 PM on April 6, 2010

I almost did this with my parents, it's called equity sharing. Here's a website that goes into more details, and HomeEquityShare.com has this calculator. Putting in your numbers, it suggests a 63/37 split in your dad's favor (he gets $36k profit after 3 years, you get $21k). One downside in your situation: when you decide to leave in 2-3 years, you either have to sell the place or your dad has to buy you out.
posted by AlsoMike at 7:39 PM on April 6, 2010

The sticky part is what happens when you leave in 2-3 years. Are you going to be taking part in the landlord duties? If not, how are you going to equitably share the rent from the new renters?

Alternately, he could just treat you like regular renters. He puts down the money and gets the mortgage. He's responsible for insurance and taxes. You pay the rent and be the best tenant ever. You don't get any equity, but after 2-3 years you wouldn't have built up any appreciable amount anyway. If you're moving out, how are you going to be affording the 50/50 split in addition to rent/a new mortgage?

I think you might be well advised to talk to someone who has experience in this sort of arrangement - either a real estate lawyer or a financial planner. They'll be able to ask the right questions and get this set up in a way that won't cause any bitterness down the line if something goes poorly.
posted by stoneweaver at 8:02 PM on April 6, 2010

You want a real estate lawyer, yes, and you also want a tax professional -- not H&R Block either -- who can advise you on how to handle the rental income and expenses.

I was thinking it'd be a good idea for tax and investment purposes for us to be part owners of the house.

This is called a shared-equity financing arrangement. The tax consequences are potentially tricky, so make sure you have guidance. In particular, review Ch. 5, Personal Use of Dwelling Unit, of Pub. 527.

For 2-3 years, though, I would be concerned that this wins neither of you anything. You'll have a depreciation give-back that could wipe out any gains (there are ways to handle this, depending), and your dad gets only part of the tax benefit from investment ownership. Be sure you run the numbers on the year-by-year tax situation for both parties all the way through various scenarios of closing out your interest.
posted by dhartung at 9:51 PM on April 7, 2010