How to Help Your Family Members to Buy their First Home
I found this interesting article on how parents can help their children to buy their first home. There is a way, though, I would suggest that you consult with the bank or what your partner thinks about it.
SHARED EQUITY: HELPING FAMILY MEMBERS BUY THEIR HOUSE
This is an arrangement where you — as investors — own a portion of the property with your children. Under a shared equity arrangement, there generally are two separate entities. You (and your spouse, if applicable) would be considered the owner-investors, and your son and daughter-in-law would be considered the owner-occupants. The four of you would take title to the property. You could own fifty percent, for example, with your children owning the remaining fifty percent. Your children, as owner-occupants, would pay half of the monthly principal, interest, taxes and insurance, as well as half of the estimated fair market rental of the property. You, as owner-investors, would pay half of the monthly costs, would receive the rental income, but would also be able to get some tax benefits if the transaction is properly structured.
In today’s market conditions, where prices are clearly higher than many young couples can afford, shared equity may be the only way to permit our younger generation to get into the home ownership arena.
Here is a general outline of how shared equity works. Although there is no magic formula by which one takes title, often — especially when dealing with family — title is taken on a 50-50 split.
The owner-occupant and the owner-investor each pay 50% 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 your children — as owner-occupants — will only own half of the house, they will have to pay 50 percent of the fair market rental to you as owner-investors. This rental is considered income to an owner-investor, and must be included in your tax return. The main advantage for the owner-investor is that you can depreciate 50% of the property. However, this depreciation is subject to the passive tax rules which Congress enacted with its sweeping tax reform legislation in 1986.
There are a number of legal requirements for qualifying for the shared equity program.
1. 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 ask a real estate agent to give you a statement in writing as to what they believe is the fair market rental of the property. 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 to challenge the shared equity concept. A Tax Court opinion has ruled that owner-occupants could pay a somewhat lower rent than fair market rental because the investor will not have any vacancy losses, and because the owner-investor will save the additional costs of hiring a property manager.
A safe harbor would be to deduct 15% from the fair market value, and then your children, as owner-occupants would pay half of that amount to you.
2. There must 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 terms and conditions?
These very serious questions must be resolved, and it is strongly recommended that you do so now while you are still talking with your children. As harsh as it may sound, parents and children often get into major fights, and you do not want to wait until you start having problems in an effort to resolve these important questions.
3. One of the owners must actually occupy the property as his or her principal residence.