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Author: Tiddman 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 121095  
Subject: Re: Shared rental property Date: 9/9/2011 9:34 PM
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What is the new agreement (after the refi) on how the monthly/annual profits and losses are to be split? IOW - if at the end of the year the rental made money, who gets the money? Or if at the end of the year the rental lost money, how is that loss going to be financed?

The short answer is that there is no such agreement (yet?). If the answers to these questions are ambiguous without such an agreement, maybe there needs to be one, but that is what I am trying to figure out, if the economics follow the ownership and/or invested capital somehow.

Further, how are the sale proceeds going to be split when the property is ultimately sold?

That is another good question. To me the simplest and fairest approach would be that each party is "made whole" by the proceeds (assuming there are enough) then the remainder (if any) is split 3 ways, but this is probably another good topic for a written agreement.

Do you want to know how to treat your arrangement for tax purposes, or are you really more interested in ideas on how to make this situation fair for the three parties involved?

Well you have once again hit the nail on the head. As you infer, this is a contemplated transaction that makes a lot of sense economically, but before committing, each party is trying to understand the tax implications, which might affect their interest in the deal.

Did I just ask another question?

Sometimes the best answer is a good question :-)

I am a random CPA.

You are anything but random, and I have been indebted by your advice for many years. Thank you for your attention to this question.

I assume that each one inherited an undivided 1/3 interest in the property and that there have been no subsequent conveyances to change that arrangement.

Yup.

I further assume that you mean two on the mortgage note and all three on the mortgage. Or are you stating the the new lender will be satisfied with a lien on an undivided 2/3rds interest in the property?

Well the lender is okay with 1, 2 or 3 of the parties being on the new mortgage, as long as their underwriting guidelines (i.e. debt ratios etc) are good, which leads to this question(s). The lender doesn't care about each person's tax situation after the transaction, but they do. I suspect that the lender holds each person wholly responsible for the entire property and mortgage regardless of the splits.

Why would ownership percentages change?

Well this is part of the question. Is ownership determined by ownership of the property, or participation in the mortgage? Can you have a property owned by 3 people but with only two on the mortgage? That seems strange because one person would have an unencumbered interest in the property, while two would be responsible for a mortgage on the whole property but only hold 2/3 of the property between them.

And why would cost bases be so different. As I understand the rules, principal paydown does not change the basis of an owner. "Closing costs" covers a wide array of costs, so of which do not affect basis and some of which might affect basis.

This is my thought too, with the caveat that some costs of a mortgage refi can be added to the cost basis. If some but not all parties participate in the refi, then only some might have their basis adjusted.

In addition to Peter's questions, what arrangements are the owners intending to make? It is not at all clear to me what the owner intend or desire.

Well it is kind of a chicken and egg thing, everyone is trying to understand the economics and tax consequences before agreeing to terms.

Have they considered just selling?

I guess the short answer is yes, though clearly this is not the market for selling properties, and is the market for refinancing them. Even without much equity, a rental property financed at 3-4% provides attractive returns. Comparing putting cash into a rented property to cut the interest expense in half vs. buying a new property or other investment options makes this look interesting.

The refinance will complicate handling of the property. One owner has had a significant reduction in income. Is the loss of income the reason they don't want to include his name on the mortgage application or is it because they have a problem with their credit score? The second owner is also weak financially. What if they can't obtain a mortgage in just two of the three property owners names?

Without getting too far into the details, two of the owners are strong financially and either one could probably carry the mortgage by themselves without a problem. One desires to commit less capital to this deal, yet they still wish to partner in order to share the load and the returns.

I helped an elderly relative with managing an inherited properties that was split between her and a SIL. With even interest in the properties, management wasn't that difficult. A partnership would only have complicated the management. Sale of the property was forced when the SIL passed away.

I would think that this kind of thing happens fairly often. Properties are often inherited, often by more than one person, and usually some of those people have more interest and money to invest than others. These kinds of arrangements are common in commercial real estate joint ventures for example. Despite some apparent complexity, it seems that this should be ground well trodden.

I know someone whose grandmother passed and the house was inherited by 19 people (kids, grandkids, etc). Nobody wanted to live in it and pay rent to the other 18, yet nobody wanted to give up their interest in "grandma's house". So they found a tenant, and were left stuck figuring out how to split up the ownership and P&L among 19 people. This is the same kind of situation I am describing. I would think that this kind of thig happens all the time.
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