Given the astronomical house prices around the San Francisco Bay Area and Silicon Valley, first time home buyers often have to resort to creative methods to finance their purchase. While the following is not intended to provide tax advice in any way, it is true that some of these methods may have been employed to somehow minimize tax consequences.
The most traditional method was the parent-child purchase. Often as part of an early estate planning method, parents would purchase a property with their child as joint tenants with rights of survivorship. They co-signed the loan together and the child made the mortgage payments. Over time, once the parents pass away, the house would revert in entirely to the child.
Another variation on that theme was the parent carryback. That is, in the circumstances where the child would purchase the family home from his or her parent, the parent would carry back a note for some portion of the purchase price. The child could (and should) make loan payments over the years to the parent. Over time, the parent could also choose to forgive a portion of the loan each year, thereby dramatically reducing the cost of the purchase. This method had the benefit of providing the parent with steady income after their retirement, in addition to assisting the child to breaking in to the real estate market.
Other times the parent may make an outright gift to contribute to their child's downpayment on a house. Of course, over a certain amount, that gift is considered income to the child and would have tax consequences. Due to the high house prices here, it is unlikely that the gift tax cap amount would yield a sufficient down payment on a house. As a result, the parent-child purchase has now evolved to include the Owner-Investor / Owner-Occupier relationship.
The parents and child enter into an Equity Sharing Agreement whereby the the child intends to occupy the property and provide sweat equity. The parents are investors and will collect rent or some other consideration for their investment. This agreement is intended to provide a contractual relationship between the parents and child in order to return the parents' investment to them once the property is sold or re-financed.
Equity Sharing Agreements, sometimes called Joint Tenancy Agreements or Tenancy-in-Common Agreements are also frequently used between siblings for private loans, same-sex partners and other shared housing arrangements like co-ops. Lawyers who draft these agreements for the investors and occupiers should ask the parties what type of exit vehicle the parties envision. Though the parties can choose an arbitrary duration like 10 years, rarely does a borrower stay in one loan that long. Instead, the sale or refinance of the property is more likely and is the common terminating event for the equity sharing agreement.
It's important that the attorney walk the parties through the mechanism of how to value the sweat equity versus the initial capital investment as well. For example, what happens to any capital cost improvements made by the occupiers? If they spend $30k on the roof, the life of that improvement is far longer than say, a new kitchen, which may only be 10 to 15 years. The parties should agree to an equation for valuing those improvements and balance the ownership percentages if the property appreciates tremendously, as is the present case in the Santa Clara Valley.
A co-ownership agreement brings with it a myriad of issues and a skillful attorney can bring about the discussion needed to make good decisions on equity valuation, termination and default events (such as bankrupty or judgments against a party) and survivorship issues if one of the parties is incapacitated.
Recent Comments