Adult children may be able to acquire a more expensive home than they might otherwise
afford by using a shared equity financing arrangement, under which parents or other
relatives share in the purchase and cost of maintaining a house used by the children
as a principal residence. The nonresident owner rents his or her portion of the home
to the resident owner and obtains the annual tax benefits of renting real estate if
the statutory requirements are satisfied. Since the child does not own 100% of the
home, he or she is the relative's tenant as to the portion of the home not owned and
rents that interest from the relative at a fair market rate.
A shared equity financing arrangement is an agreement by which two or more persons
acquire qualified home ownership interests in a dwelling unit and the person (or
persons) holding one of the interests is entitled to occupy the dwelling as his or
her principal residence, and is required to pay rent to the other person(s) owning
qualified ownership interests.
Under the vacation home rules, personal use of the home by a child or other relative
of the property's owner is normally attributed to the owner. However, an exception to
the general rule exists when the dwelling is rented to a tenant for a fair market
rent and serves as the renter's principal residence. When the tenant owns an interest
in the property, this exception to the general rule applies only if the rental
qualifies as a shared equity financing arrangement.
Example: Shared equity financing arrangement facilitates child's home
ownership. Mike and Laura have agreed to help their son, Bob, purchase his
first home. The total purchase price is $100,000, consisting of a $20,000 down
payment and a mortgage of $80,000. Mike and Laura pay half of the down payment and
make half of the mortgage payment pursuant to a shared equity financing agreement
with Bob. Bob pays them a fair rental for using 50% of the property, determined when
the agreement was entered into.
Under this arrangement, Bob treats the property as his personal residence for tax
purposes, deducting his 50% share of the mortgage interest and property taxes.
Because his use is not attributed to his parents, Mike and Laura, they treat the
property as rental. They must report the rent they receive from Bob, but can deduct
their 50% share of the mortgage interest and taxes, the maintenance expenses they
pay, and depreciation based on 50% of the property's depreciable basis. If the
property generates a tax loss, it is subject to, and its deductibility is limited by,
the passive loss rules.
One drawback to shared equity arrangements is that the nonresident owners will not
qualify for the gain exclusion upon the sale of the residence. The result will be a
taxable gain for the portion of the gain related to the deemed rental. The gain may
also be subject to the 3.8% net investment income tax (NIIT). Parents should consider
guaranteeing or cosigning the mortgage, instead of outright joint ownership, if
excluding potential future gain is a major consideration.
If it is anticipated that the resident owner will ultimately purchase the equity of
the nonresident owner and the rental will generate losses suspended under the passive
loss rules, special care must be taken when the lease terms are agreed to, because
suspended passive losses normally allowed at disposition are not allowed when the
interest is sold to a related party. This problem can be minimized by making a larger
down payment that decreases mortgage interest expense, or by charging a rent at the
higher end of the reasonable range for the value of the interest being rented to the
This publication is distributed with the understanding that the author, publisher and
distributor are not rendering legal, accounting or other professional advice or
opinions on specific facts or matters, and, accordingly, assume no liability
whatsoever in connection with its use. The information contained in this newsletter
was not intended or written to be used and cannot be used for the purpose of (1)
avoiding tax-related penalties prescribed by the Internal Revenue Code or (2)
promoting or marketing any tax-related matter addressed herein. © 2015