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Sharing Home Equity with Your Child

Housing prices continue to go through the roof in many parts of the country. You may be asking yourself: How are my children ever going to afford to buy a nice-sized home in a desirable area? Probable answer: They won't.

One possible solution is to enter into an “equity sharing” arrangement with your child. As the name implies, you share the ownership rights in the home, but you get to keep the lion's share of the tax breaks. After a specified period of time, you sell your interest in the home to your child.

With this type of arrangement, your children can gain a foothold in the housing market without dire consequences. At the same time, you may be able to claim tax deductions that can benefit people in your high income tax bracket.

Hypothetical example: Let's say your daughter is getting married in June and would like to move into a single-family house. Unfortunately, the newlyweds can't afford the home they have their hearts set on. Instead of letting the couple pass up their dream house, you agree to buy 50% of the home through an equity sharing arrangement.

For starters, you pay half of the down payment for the home, while the young couple pays the other half. They move into the house and pay you a fair rental value in return. Then you use the rent money to pay expenses such as homeowner's insurance, repairs, property taxes and mortgage interest. The newlyweds are required to pay any remaining amounts. Both parties agree to split the cost of any capital improvements to the home.

Finally, the agreement includes a provision that the home is to be sold after five years (or some other period of time). The occupants are given the right of first refusal. After five years on their own, they should be able to come up with the money needed to buy you out.

Now let's see what you have accomplished. The rental income is offset by the available deductions for insurance, repairs, property taxes and mortgage interest plus depreciation based on 50% ownership of the home. You must legally own 50% of the home to claim a deduction for that percentage of the interest. Caution: Make sure you charge a fair rental value to the occupants or the IRS may challenge the deal.

If you show a loss for a given year, it is treated as a passive activity loss (PAL). You can generally use the PAL to offset up to $25,000 of ordinary income such as salary. If your other annual income exceeds $150,000, the PAL is carried forward to future years. And, when you finally sell your interest in the home, any gain is taxed at favorable capital gain rates.

True, the newlyweds will get shortchanged on their share of the usual tax deductions. But the tax breaks are worth a lot more to you in your high tax bracket than they are to the young couple in their lower bracket. Plus, they are able to live in—and eventually own completely—the house of their dreams.

Note: Equity sharing usually involves family members, but it can also work with nonrelated parties. In any event, have an experienced attorney handle all the paperwork.

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	[ return to list ] Sharing Home Equity with Your Child Housing prices continue to go through the roof in many parts of the country. You may be asking yourself: How are my children ever going to afford to buy a nice-sized home in a desirable area? Probable answer: They won't. One possible solution is to enter into an “equity sharing” arrangement with your child. As the name implies, you share the ownership rights in the home, but you get to keep the lion's share of the tax breaks. After a specified period of time, you sell your interest in the home to your child. With this type of arrangement, your children can gain a foothold in the housing market without dire consequences. At the same time, you may be able to claim tax deductions that can benefit people in your high income tax bracket. Hypothetical example: Let's say your daughter is getting married in June and would like to move into a single-family house. Unfortunately, the newlyweds can't afford the home they have their hearts set on. Instead of letting the couple pass up their dream house, you agree to buy 50% of the home through an equity sharing arrangement. For starters, you pay half of the down payment for the home, while the young couple pays the other half. They move into the house and pay you a fair rental value in return. Then you use the rent money to pay expenses such as homeowner's insurance, repairs, property taxes and mortgage interest. The newlyweds are required to pay any remaining amounts. Both parties agree to split the cost of any capital improvements to the home. Finally, the agreement includes a provision that the home is to be sold after five years (or some other period of time). The occupants are given the right of first refusal. After five years on their own, they should be able to come up with the money needed to buy you out. Now let's see what you have accomplished. The rental income is offset by the available deductions for insurance, repairs, property taxes and mortgage interest plus depreciation based on 50% ownership of the home. You must legally own 50% of the home to claim a deduction for that percentage of the interest. Caution: Make sure you charge a fair rental value to the occupants or the IRS may challenge the deal. If you show a loss for a given year, it is treated as a passive activity loss (PAL). You can generally use the PAL to offset up to $25,000 of ordinary income such as salary. If your other annual income exceeds $150,000, the PAL is carried forward to future years. And, when you finally sell your interest in the home, any gain is taxed at favorable capital gain rates. True, the newlyweds will get shortchanged on their share of the usual tax deductions. But the tax breaks are worth a lot more to you in your high tax bracket than they are to the young couple in their lower bracket. Plus, they are able to live in—and eventually own completely—the house of their dreams. Note: Equity sharing usually involves family members, but it can also work with nonrelated parties. In any event, have an experienced attorney handle all the paperwork. [ return to list ]
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