By Benny L. Kass
Saturday, August 16, 2008
Q: My sister and I inherited our family home. It has no mortgage debt. We agreed to sell it, but my husband suggested that we might buy my sister's half and use the property as a source of rental income. My sister is agreeable to this arrangement. How would we find out whether this would be a profitable investment? We would have to finance a loan, and some repairs would be needed before we could rent it out. If we buy my sister's portion of the property and do not use an agent, how do we give her a fair amount?
A: It is nice to hear that you and your sister are in agreement about the family home. All too often, siblings disagree in this situation, especially when one of the owners wants to live in the house and the other wants to sell.
My first question: Have you considered keeping the house in both of your names? Does your sister need the money now? Because you are talking to each other, it may be a good idea for the two of you to start a partnership, and use the house as a potential long-term investment.
How do you decide whether it is a good investment? That's a tough question. Do you know the neighborhood? Have houses appreciated in value in the past five to 10 years? What is the average age of the residents in the area? Have younger married couples with children moved in -- or moved out? Where are the local schools, shopping centers and transportation facilities?
If you're not familiar with the area, the Census Bureau has a lot of statistics that might be useful. Local governments have planning offices that should be able to assist you. You can also talk with real estate brokers, who will be able to provide you with comparable sales figures and market statistics.
If your sister does not want to join you in this venture, you two have to agree on a buyout price. Presumably when you inherited the property, there was a probate estate and someone obtained an appraisal for tax purposes. If a lot of time has not elapsed, you can use that appraisal. Alternatively, you and your sister can hire an independent appraiser to give you an estimate of what the house is worth.
Often, when faced with the situation where one party wants to sell high and the other wants to buy low, we use the three-appraiser method. You and your sister each hire separate appraisers. If their respective valuations do not differ by more than 10 percent, the agreed-upon sales price will be the average of the two numbers.
If, however, there is a greater difference, then the two appraisers hire a third one (at your joint expense), and the agreed-upon sales price will be the average of the three appraisals.
Let's assume that the agreed-upon market price is $500,000. Does that mean that you would owe your sister $250,000 to buy her out? Not necessarily. You do not need a real estate agent for this transaction and thus would not have to pay the 4 to 6 percent commission that's built into most deals. So I would deduct 4 percent ($20,000) to reach the sales price of $480,000.
Although you are sisters and appear to be friendly, I recommend that each of you retain your own lawyer. You will have to enter into a sales contract, which will spell out all of the terms and conditions of the sale. If you have to borrow money from a commercial lender, the lender will insist on reviewing that contract.
There are many closing costs involved in this transaction; perhaps the most expensive is the recordation and transfer tax, which, depending on where the property is located, could be as high as 4 to 6 percent of the sales price.
Next, you have to decide how to pay your sister. In our example, you will owe her $240,000, less any closing costs on which you have agreed. If you have the cash, you can just write her a check -- but I don't think this is a good idea. You have property with a lot of equity, so why not tap into that equity instead of depleting your savings?
Your sister can give you a deed to her interest in the property and take back a mortgage. For example, you can give her $40,000 and sign a promissory note, secured by a deed of trust (the mortgage document) in the amount of $200,000.
The two of you will have to work out the terms of this transaction. Will you pay only interest for a number of years or will the note be amortized -- that is, the principal paid off over time -- and if so, for how long? What interest rate will you pay on your note? You can pay the market rate, but because this is a family transaction, you can also pay what is known as the "applicable federal rate." These are interest rates that the Internal Revenue Service will allow without challenge. They can be found at www.irs.gov.
If your sister wants the money now, you will have to get a mortgage. While investment loans are becoming harder to obtain in today's economy, you should not have any difficulty, especially because you will be asking for a loan for only about half the value of the house. Lenders look at the loan-to-value ratio, and the more equity in the house, the greater chance you have to get a loan -- and at favorable rates.
Your lender will require that you have adequate insurance coverage on the property, which you should have anyway.
You indicated that some repairs would have to be made. You and your sister should obtain at least two bids from licensed contractors. If you have to buy your sister out, half of this cost should be deducted from the sales price.
Your lender should also be willing to increase the amount of your loan to cover these repair costs.
If you will not need a loan to buy out your sister, consider obtaining a line of credit from your bank so that you have the money for the repairs.
If you decide to rent out the house, make sure that you understand local landlord-tenant laws in the jurisdiction where the house is located. For example, the District has very strong tenant-protection laws. Consult a local lawyer for specific advice. Your lawyer can also provide you with the lease forms that you will need.
Do you want to handle the tenant issues on your own, or do you want to hire a property manager? Not everyone wants to be a landlord. It's not fun getting midnight calls about broken plumbing. Talk with a number of property managers to determine what they can do for you, and what they will cost.
Finally, you should consider creating a limited liability company to hold title to the property. Depending on where the house is located, it may cost you a lot of money to transfer the house to that company, but in my opinion, the protections offered by an LLC outweigh the costs.
If you play by the rules -- do not mingle your personal funds with those of the LLC, and always sign legal documents as the "member" of the LLC and not in your individual capacity -- your personal assets should be protected if there is litigation involving your investment property.
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 or contact him through his Web site, www.kmklawyers.com.
View all comments that have been posted about this article.