Is A Home Buyer Equity Sharing Arrangement a Good Thing in This Market? -- Part One

A man contacted us a week ago about his predicament. He and his wife had entered into an EQUITY SHARING AGREEMENT with a mortgage broker during 2006 to buy a home in South OC. This family made payments to the mortgage company as rent on the agreement. The mortgage company in turn made some payments to the lender on the note. The mortgage company went out of business six months ago and is not now making payments. This family could be facing foreclosure and evication? Was this EQUITY SHARING ARRANGEMENT a good thing?

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Investments in real property can take various forms, such as syndication, partnership, limited partnership, or LLC, where none of the parties live in the property and the property is rented to tenants.

An EQUITY SHARING ARRANGEMENT involves one party (the owner-occupant) occupying the property and the other (investor) putting up the bulk of the financing. Both the owner-occupant and the investor can receive tax benefits and share in the profit according to their investments as described in their equity sharing agreement. First-time homeowners are the typical owner-occupant while the investor can be a family member, a seller, or any real estate investor.

EQUITY SHARING is a form of ownership and investment that allows two or more parties to share an interest in real property. It is frequently used in situations where, because of the high cost of housing, one party, the investor, puts down the bulk of the downpayment, and the other, the owner-occupant (also caller the "occupier") puts down little or no downpayment but agrees to pay a monthly amount consisting of "rental payments," mortgage payments, taxes, and other specified charges, and lives in the dwelling. The owner-occupant may pay all of the mortage costs as "rent" or may pay two different amounts, one portion representing the rent and the other representing mortgage, which would include interest for which he or she could receive a tax deduction.

Depending on the specific terms of the contract, there are tax and ownership advantages to EQUITY SHARING.

Be very careful. There are potential tax and financial pitfalls in an equity sharing agreement that is loosely worded. Since the owner-occupant does not own 100 percent of the property, he or she must pay a "fair market rental" to the investor for living in the dwelling. The rent paid by the owner-occupant should be proportional to the percentage interest that the owner-occupant has, and should be based on the fair market rental value determined in good faith. Ideally, they have both signed the note and trust deed and are also on title. The rental paid to the investor is taxable income, and the interest paid on the mortgage is tax deductible. On the other hand, the investor also pays the remaining fraction of the mortgage each month based on his or her proportional share of ownership and can deduct the interest as an expense of the property, subject to passive loss and other restrictions.

Be careful with EQUITY SHARING AGREEMENTS. Consult a qualified Realtor and also with an experienced real estate lawyer in your area and jurisdiction.

Posted by Harrison K. Long, Explore Properties Group, May 3, 2008
Source: California Association of Realtors, March, 2008