Q I have a standard mortgage on a single-family house that I own by myself. I would like to add my live-in girlfriend to the deed. She will pay me half the current value of the house. If I do this, can I retain my current mortgage, thereby avoiding more closing costs and the loss of my favorable mortgage rate? Also, is this a taxable event that would require me to pay capital-gains tax? I know that the simplest solution would be for us to get married, but there are other financial issues involved and we would like to avoid marriage now if possible.
AThe best and simplest way to accomplish your goals would be for you to get married. However, because that's not in your plans, you have several issues to consider.
Your mortgage: Let's assume that you purchased your home for $200,000 and that it is now worth $300,000. Your mortgage is $175,000. If your girlfriend is going to pay you half the value of the house, is she going to give you $150,000 in cash (half of $300,000)? Or is she going to pay you $62,500, the difference between half of the current value of the house and half of the mortgage debt -- that is, is she buying half your equity ($150,000 minus $87,500 equals $62,500)?
Do you plan to take all the mortgage interest tax deductions on your own, or will they be divided equally? If your girlfriend wants those tax deductions, she will have to be added to the deed of trust (the mortgage) that you have with your lender. A taxpayer cannot take deductions for mortgage interest unless the taxpayer is obligated under a secured deed of trust, which means that the document must be recorded where the property is located.
Your current mortgage probably contains a "due on sale" clause, which means that if you sell all or a portion of your property, your buyer cannot automatically assume your loan. While there are several situations in which the clause legally cannot be asserted (such as where property is transferred in a divorce or death situation), there is no such exemption for a girlfriend.
If your friend is not interested in the tax deductions, then I suspect that your current lender will not object to having her name added to the title but not the mortgage. However, if your friend wants to take the deductions, you will have to modify your loan documents. That may give your lender the opportunity to increase your favorable mortgage interest rate.
Tax consequences: Again, assume you paid $200,000 for the house and it's worth $300,000 now. If you sell half the property to your girlfriend, you will make a profit of $50,000.
Generally, when you sell a house, you can as a single taxpayer exclude $250,000 of profit from capital gains taxation if you have owned and lived in the house for two of the previous five years. In your situation, assuming you meet those tests, you won't pay tax on the $50,000 profit now. In the future, if you sell the house (and if you still meet the tests) that $50,000 counts as part of the total $250,000 exclusion. Talk with your financial adviser to make sure you understand the implications.
There is another way of resolving your situation, short of an actual sale. Your girlfriend can lend you her "purchase price," take back a promissory note and secure your obligation with a recorded second deed of trust. Should you ultimately get married, she can forgive and cancel the debt. There are taxable consequences involved when a debt is canceled, and your financial adviser should be consulted.
No matter how you structure your transaction, I strongly recommend that you and your girlfriend enter into a written partnership agreement, which should be completed before you transfer any interest in the property to her.
There are a lot of issues such an agreement should address. What happens if one of you dies? Do you want your girlfriend to inherit the entire property, in which case title should be held as joint tenants with rights of survivorship? Or do you want your heirs and relatives to get the property, in which case title should be held as tenants in common?
What happens if one of you decides to end the relationship? What will happen to the house?
Who will pay the mortgage? What if one of you is unable to make the monthly payments?
What about furniture? Who owns it? How will it be disposed of should you split up?
Those are important questions that should be answered while you are friendly toward each other. It is cheaper to resolve them now, rather than pay two lawyers to resolve issues when you are not talking.
Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.