Sharing equity w/out rent or taxes
April 5, 2010 7:54 AM   Subscribe

I would like to help a family member by paying off their mortgage in exchange for equity in their house. The problem is how to do this in way that is financially fair, simple, and with minimal taxes. I can't see a tax advisor until after April 15th so I hoping to get some sense of what the tax consequences might be if they pay all expenses including improvements up to an certain amount and we don't get any $ until the house is sold.

The set-up: family member owns a nice house in very good neighborhood. Current mortgage is 60% of the value of the house. We are proposing to payoff the mortgage in exchange for 60% equity in the house. The plan is to sell the house in 10 years when the children leave home.

In lieu of paying us rent, they would pay
a. all "landlord" expenses including routine maintenance, insurance, property taxes
b. costs of preparing the house for sale (i would put that at about $15k - new carpet, paint etc)
c. $x of upgrades and improvements
- $x is set at time of signing to be roughly equal to reasonable rent minus landlord expenses times 120 months.
- improvements made at their discretion both in terms of what needs doing and when
- if cumulative cost of improvements exceeds $x, we will pay 60% of the excess
- if the cumulative amount spent is less than $x then they will pay us 60% of the shortfall out of their share of the equity when the house is sold.

Since they are paying over time is roughly equal to what the rent would be, I'm hoping to avoid gift tax and since we use cash accounting and I won't get any money from them until the house is sold, I am hoping there is no reason to pay taxes until we get the money.
posted by metahawk to Work & Money (7 answers total)
You're going to want a lawyer to help you with this. You're talking about getting some kind of property interest, which would probably need to be recorded. This definitely needs to be handled in writing--any contract related to ownership interests in land must be in writing to be enforceable--and such things are best left to the experts.

I don't think the tax situation is as simple as you make it out to be either. You're talking about someone else making improvements to your property. That's an accession to wealth the IRS will care about, even if it doesn't involve cash changing hands.

Contact a local real estate attorney. You're in over your head.
posted by valkyryn at 8:03 AM on April 5, 2010

{lack of backstory-filter-comment}
Are you really helping your family, or are you helping yourself to a nice payoff down the road?

I’m not saying that helping someone is wrong if you stand to benefit, but it feels like there’s some profit motive here. My reason for pointing this out is NOT to be a dick, but to shed some light on the possibility that the potential payout may be coloring your perspective on the situation.

Conventional wisdom says that gifting is better than loaning – when it comes to family and friends.
If someone is in a rough spot, perhaps getting them through that with a gift or small loan (that you’re prepared to turn into a gift) could be better than taking a majority interest in someone’s home.

Again, I don’t know the backstory. If you go through with it – use a lawyer, and make sure that the docs get reviewed by their lawyer. If fair is the goal, both side need a lawyer.
posted by terpia at 8:16 AM on April 5, 2010

Nthing the lawyer comments and valkyryn's 'you're in over your head' comment.

I think you should set this up as you would, if the family member were a complete stranger. I've seen situations like this (family+business+real estate) become very ugly and problematic.

Why don't you just buy their house outright now, pay them their share of what they own so far, and then pay off the mortgage on your new house while renting it to them?
posted by thermonuclear.jive.turkey at 8:42 AM on April 5, 2010

Also, I would be very very careful about giving them the cash to pay off the mortgage but still having the deed or part of the deed in their name. They could take out another home loan against the house or have liens against the house and you would get a very nasty surprise when you went to sell the house. If I were you I would get a mortgage for the 40% and pay off the existing mortgage.
posted by zia at 10:38 AM on April 5, 2010

This is basically a mortgage, and you'll need a lawyer and a contract. I'd get the house appraised by an experienced appraiser, rather than use realtor guesstimates. Also consider, you won't have use of the house during this time, and that's non-trivial, as you also don't have use of your money.
posted by theora55 at 4:33 PM on April 5, 2010

Response by poster: thanks for trying to be helpful but valkyryn is only one who addressed the actual question asked.

In terms of your questions, we are absolutely using real estate lawyer (or two) in the state where the house is and will consult with a tax specialist after the 15th but right now we are just trying to figure out how we want to do this. The other side is very happy that we can do this and we have been trying to brainstorm different arrangements that are financially reasonable for us and them.

The house is in a VERY expensive part of the country. They already have 40% equity and want to keep that, so buying 100% is not an option. Neither is making it a gift (barring a catastrophe, I expect to get my money back eventually - and I have enough reserves that I can afford to wait.)

By the way, this gives us no control over what happens in the house nor the timing and nature of any improvements. The timing of the sale is based on the fact they announced when they bought the house that they planned to sell when the youngest graduated high school. If not, there is always the option for them to get a mortgage at that point and pay us off. And if we need to wait a little longer, we will just wait (this is family after all).

Anyway, I was just trying to get some idea if this structure might work from a tax perspective or if we need to go back to the chalkboard....
posted by metahawk at 5:22 PM on April 5, 2010

Response by poster: In case anyone reads this later - we went for a much simpler arrangement. We put in enough money to pay off the mortgage and become a % owner of the property. All landlord type expenses and improvements are split based on % ownership (which lets my relatives make some needed improvements sooner since we will pay our % of the cost).

To keep the taxman happy, they will calculate a fair market rent, less 15% since they are also acting as building manager. They will pay me a share of that amount based on our % ownership (and keep the amount that they owe themselves as their own landlord). I will have to report my share of the income and expenses on my taxes in the usual way for a rental property.

They did the math and still helps enough with the cash flow that it will make a difference even though they will be paying us some rent. From the tax/accounting perspective, this is a much more traditional arrangement and less likely to trigger audit questions.
posted by metahawk at 8:03 PM on August 16, 2010

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