Q. I am considering purchasing a town house as a joint venture with a young couple who would have difficulty qualifying for a mortgage on their own. We propose that the young couple own a one-half interest in the property and occupy it as their residence.
They would pay half of the monthly PITI (principal, interest, taxes and insurance) plus half of the estimated fair market rental of the property. We would pay the other half of the monthly cost and receive the rental income. Is there a way that we can depreciate our interest in the property? Please advise.
A. Shared equity is the definition of what you are describing, and in my opinion it is a concept worth considering by every real estate investor and buyer.
In 1981, Congress amended a section of the Internal Revenue Code and authorized investors to take their share of deductions for depreciation, interest, taxes, insurance, condominium fees and other similar expenses for property rented by a relative or an owner occupant.
Before 1981, if, for example, a father owned property with his son who was living in the property, the father was prohibited from taking the depreciation deductions.
In 1981, Congress recognized the inequity of this situation, and by amendment permitted what is now known as "shared equity." Unfortunately, as of today, the Internal Revenue Service has not yet issued final regulations on the concept.
However, because the IRS has issued draft regulations, and because the law is on the books, shared equity can and should be considered a very valuable real estate investment tool.
Here is a general outline of how shared equity works. We have two parties. One is known as the owner occupant and the other is known as the owner investor. Let us assume a 50-50 split, although the property does not have to be divided equally.
The owner occupant and the owner investor each pay 50 percent of the monthly mortgage costs and taxes. Both parties are entitled to deduct from their income taxes their share of the mortgage interest and the real estate taxes.
The owner occupant pays rent to the owner investor. In our example, because the owner occupant owns only half of the house, he or she pays 50 percent of the fair market rental to the owner investor.
This rental is considered rental income to the owner investor. However, the main advantage for the owner investor is that he or she is entitled to depreciate 50 percent of the property.
There are a number of legal requirements for qualifying for the shared-equity program, and this column will highlight three of them.
First, the owner occupant must pay a fair market rental for the portion that he or she does not own. Perhaps the best way to determine this fair market value is to have an appraiser (or a real estate agent) give you a statement in writing as to what he believes the fair market rental of the property is.
With such a document in your files, you should be able to justify the rental if and when the IRS comes knocking at your door. There are those who believe that owner occupants could pay somewhat less than fair market rental because they are going to be managing the property themselves, thereby saving the owner investor the additional cost of hiring a property manager. This argument has merit, but unfortunately IRS regulations have not yet been finalized.
A second requirement is that there be an equity-sharing agreement. This document -- which must be in writing and signed prior to the purchase of the property -- should spell out the terms and conditions between the owner occupant and the owner investor.
For example, when will this agreement terminate? Who has the right to buy out the other and under what arrangements?
These very serious questions must be resolved, and I strongly recommend that you do so now while the two parties still are talking to each other. You do not want to wait until they are at odds with each other to try to resolve these questions.
A third requirement of shared equity is that one of the owners actually occupies the property as his own personal residence.
It is not possible in the space of this column to fully analyze the shared-equity arrangement.
However, it does have tremendous possibilities for such people as:
Parents in a high tax bracket who want to help their children with down payment and closing costs.
* Children in a high bracket who want to help retired parents purchase a retirement home.
* A friend who wants to lend money to a purchaser to assist in a home purchase.
* An investor interested in a residential real estate investment who is looking for a solid, limited-risk shelter.
* Potential buyers with limited savings but good income who need a bigger house than they can afford.
The possibilities of shared equity are unlimited. But it does require careful planning, a well-drafted written agreement, and a full understanding of the tax and financial considerations involved.