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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121341  
Subject: Re: Shared rental property Date: 9/10/2011 3:04 AM
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OK - so we're trying to structure the transaction ahead of time rather than figure out what has already happened. Good.

Offhand, I can think of two ways to work this to make things reasonably fair. There's likely more, but it's late and the advice is free. ;-)


One way is to think of everyone as having their own separate rental property. So each person has a $100k property with an $83.3k mortgage. (That's 1/3 of the 300k property and 250k mortgage.) Now all three refinance at the same time.

One does a straight refi, rolling the refi costs into the loan. So now his loan is $85k. (That's the original 83.3k plus 1/3 of the $5k in closing costs.)

The second puts $10k in to pay costs and reduce the loan balance. Her loan is the original 83.3k plus 1.7k in costs less 10k, or $75k. Similarly, the third puts $35k in and ends up with a $50k loan.

So the three loans amount to 85 + 75 + 50 which is the 210 you specified in the OP.

Each year, then, you'd split all the income and the costs 1/3 each except for the mortgage interest. That would be split 85/210 (or about 40.5%) 75/210 (about 35.7%) and 50/210 (about 23.8%). Any cash profits would follow similarly. Decide on the cash available to distribute, then add back the total mortgage interest for the period (year, month, quarter, whatever). Divide that by 3, then charge each person with their correct share of the mortgage interest. You should end up with the person who put the 35k in to the refi getting more cash than the person who put nothing in to the refi.

When you sell the property, you'd split the sale price and all the selling costs 1/3 each - after all, you are all still 1/3 owners. But you'd have to do a little tap dance to figure out the split of the cash. Take the cash available, add in the mortgage balance that was paid off, then charge each person with their share (the 40.5%, 35.7%, and 23.8%) of the mortgage balance. The person who put nothing in to the refi will get less than the other two.



Another approach would be to look at the equity in the property before and after the refi.

Before the refi, everyone has $16.7k of equity. One-third of the $50k total equity. After the refi, the one who put nothing in has $16.7k less $1.7k (for their share of the refi costs), or $15k of equity. The person putting $10k in will have $25k of equity, and the person putting $35k in will have $50k of equity. The math still works, 300 of value less 210 loan is 90 of equity, which is the total of 15 + 25 + 50.

That makes the ownership shares 50/90 (55.6%), 25/90 (27.8%), and 15/90 (16.6%). The person putting in the $35k is buying part of the property from the other two owners.

The immediate result is that the two selling owners would need to recognize any gain on the partial sale of the property. (Losses would probably not be recognized due to related party issues.)

The up side is that everything is now split based on the new ownership percentages. There's no need to fiddle around allocating one expense differently from all of the other items. It would be a one-time adjustment to the ownership, then everything continues on based on the new ownership split.


You could probably tweak these in multiple ways to get the desired result. (One I can think of would be to engage in a bit of algebra to split the refi costs based on the "after" ownership of the loan or property rather than the 1/3 each "before" ownership.) And there may be other ways to slice and dice things. I'm sure that other creative types could come up with other solutions.

The key is to do what I think you're doing - talk this out among the three of you and come to your own decisions. Because things are going to become unequal, I'd highly recommend putting the agreement to writing. You don't need to spend thousands of dollars on an attorney to do this, just get it all down to a piece of paper so that everyone can see it and agree to it. I suspect a google search of "co-ownership agreement" or "joint ownership contract" or something similar would turn up some suitable samples you could tweak for your needs.

--Peter

PS - Here's one more idea that might be easier for everyone to understand. Create some promissory notes on the side to equalize things. The total going in to the refi is $45k. On an equal basis, that would be $15k each. The person putting $35k in is putting in his $15k. Plus he's loaning $15k to the person putting nothing in and $5k to the person putting in $10k. You could make the interest rate on the notes the same as the mortgage rate so there's no arbitrage going on. Or charge more. It's up to you. Then periodically - no less than once a year - pay the interest on the notes.

The cash flows from the rental would be split 1/3 each just as before. After the cash is distributed to each partner, then the two partners cut their own checks to the third partner to make the payment on the notes. Don't try to short cut that step, as you want the paper trail to agree with the form of the transaction.

You'd probably want to make the notes due in full if the property is sold or there is a cash-out refi in the future.
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