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Your Mortgage : Know Tax Rules When Sharing Equity in Home : Home Ownership: The IRS has some strict provisions when two parties buy a house together. Ignoring them can lead to loss of tax deductions.


With home prices skyrocketing and lenders requiring increasingly large down payments, you might be thinking about buying a home with someone else.

Perhaps you have some extra money that you can use to help your children buy a home or maybe you're the one who needs help with the down payment.

But whether you'll be teaming up with a relative or stranger, there are some technicalities involved in these so-called equity-sharing arrangements that you must address when you're writing up a contract with your co-buyer.

Among the most important is structuring the deal to satisfy the Internal Revenue Service. If you don't have a written agreement that addresses several issues, the IRS can reduce or even deny your deductions for mortgage-interest payments and the like.

"I think equity-sharing is the wave of the future," said Jim Sims of Equi-Share, a Santa Barbara-based company that specializes in putting equity-sharing deals together.

"But it's important to realize that you've got to understand the tax codes if you want to maximize your benefits. If your deal doesn't meet IRS requirements, you won't get all the tax breaks that you deserve."

More than 10% of all resale transactions in California last year--more than 50,000 sales--involved unrelated buyers, according to the California Assn. of Realtors.

Forecasters at the trade group say that figure will grow through the end of the decade, thanks to rising home prices and lower marriage rates.

The typical equity-sharing arrangement involves two parties.

First, there's an owner/investor who'll put up some or all of the down payment but live somewhere else. And second, there's an owner/occupant who will live in the home and be responsible for most or all of the monthly mortgage payments to the lender that finances the deal.

For example, say two people want to buy a $150,000 house. The owner/investor could put up a 20% down payment of $30,000 and the two would get a $120,000 bank loan to finance the rest of the purchase.

Monthly principal and interest payments on the 10 1/2%, 30-year fixed-rate loan would be about $1,100.

In a typical arrangement, the owner/occupant would write a check to the bank each month for $550, representing half the $1,100 mortgage payment. The owner/investor would write a check for the other half.

At the same time, the owner/occupant would also write another check for $550, payable to the owner/investor. This check would reflect rent for the half of the home that the investor owns.

In this type of setup, each party could be eligible to take 50% of the annual tax deductions for mortgage-interest payments.

The owner/investor might also be able to take depreciation deductions on his half of the home because a portion of it would be considered rental property. However, he would also have to declare the check he receives from the owner/occupant each month as rental income.

To appease the IRS and qualify for these deductions, however, both parties will have to make sure they include several items in their equity-sharing contract.

First, there must be a written "shared-equity finance agreement." A verbal agreement won't do.

Next, realtor Sims said, each party to the contract must have an ownership interest in the property that will last for at least 50 years.

"It doesn't mean that the two of you will have to keep the property 50 years," said Robert Giannangeli, a spokesman for the IRS.

"You can dissolve the contract or sell the home whenever you and your partner agree. It's just that the term of the contract has to be for 50 years or more in order for both of you to take the deductions."

Third, one of the parties must use the home as his primary residence.

One of the trickier IRS requirements is that the person who lives in the home pays the owner/investor "fair-market rent" for the portion of the home that the investor owns.

"If you don't meet the fair-market rent test, we can reduce or disallow some of your deductions," Giannangeli.

Sims said local realtors can usually give you an estimate of the home's fair-market rent. You can also get an idea by checking "For Lease" advertisements in the classified section of the newspaper.

In fact, it's a good idea to clip out these rental advertisements and keep them on file. If the IRS eventually questions whether you really charged fair-market rent for the property, you'll be able to submit the ads as evidence that the proper amount was indeed charged.

Since equity sharing involves such important tax and legal issues, you'll want to consult both a tax expert and knowledgeable real estate attorney before you enter any type of equity-sharing arrangement. IRS Code 280A specifically addresses shared-equity arrangements.

Sims has also written a book on equity-sharing that includes a sample agreement. Titled "Share & Grow Rich," it can be ordered for $21.30 (including tax and postage) from Altaverde Publishing, 1125 Arbolado Road, Santa Barbara, Calif. 93103.

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