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Shared Equity Financing Agreement

A unique form of co-ownership agreement is the Shared Equity Financing Agreement ("SEFA"). This agreement typically is made between family members, one who is an occupant owner and the other a non-occupant owner. The occupant owner usually is an adult child who desires to own a residence but does not have the financial clout to purchase one without help from his parent/s. The non-occupant owner usually is the parent who does not wish to make a loan to the child, but instead wishes to invest equity and obtain the tax benefits of owning rental proper is to qualify for rental property ownership tax treatment. The typical structure of a SEFA is described in the following example.

The occupant owner is a daughter, and the non-occupant owner is her father.

The non-occupant owner generally furnishes most of the down payment and closing costs for the purchase of the real estate. He will receive this money back as a priority payment when the property is sold or, if the parties choose, is refinanced.

The parties decide upon their respective co-tenancy ownership interests. For this example, the occupant owner will have a 60% interest in the real estate, while the non-occupant owner will have a 40% interest.

Under Section 280A(d)(3)(B), the occupant owner must pay "fair rental value" to the non-occupant owner for her respective share of ownership. If fair rental for the house is $2,000, she must pay her father $800 rent. This rent must be paid by a separate check to him. There have been some private IRS rulings that suggest a family discount of 10% to 15% are allowed. A discounted rent of $700 to a family member probably will not be frowned upon by the IRS.

The parties decide how to allocate payment of the expenses of the property, such as mortgage interest, property taxes, insurance, utilities, etc. They can make such allocation in any manner they wish. Usually, the occupant owner will pay the "personal" utility expenses such as gas, electric, water, cable, trash, phone. The non-occupant owner often will pay a greater than ownership proportion of the mortgage interest and property taxes.

One example of how an allocation of paying expenses between occupant owner and non-occupant owner is this: Assume the mortgage, property taxes, insurance and other normal property expenses average $2,200 per month. The non-occupant owner decides to pay $1,200 of these expenses, an amount which is greater than his ownership share of 40% ($880). Meanwhile the non-occupant owner will receive a $800 per month rent from the occupant owner by separate check (keeping in mind this monthly rent can be discounted). In terms of net cash flow, the non-occupant is out of pocket $320 ($1,200 less $800). If the non-occupant owner's depreciation is figured in, he is likely to have a net paper loss to show for his rental investment. This net paper loss will be written off on page one of the non-occupant's federal 1040 form against his ordinary income for that year.

Federal tax law allows the occupant owner to deduct all mortgage interest and property taxes paid by him, even if such payments are greater than his percentage of ownership interest. These deductions are taken on Schedule A of his federal income tax return. California state income tax law confirms with the federal tax code.

Federal tax law allows the non-occupant owner to deduct the rental property expenses he pays (e.g. property taxes, mortgage interest, etc.) even if such expenses paid are greater than his proportionate ownership interest in the property. The non-occupant owner may take a depreciation deduction proportionate to his ownership interest on Schedule E.

Payments of property expenses should be made from a joint bank account (named perhaps the "Dana Daughter and Fred Father SEFA Account"). Occupant owner will deposit $1,000 into the account each month, and non-occupant owner will deposit $1,200 each month (remember the non-occupant owner is paying more than his 40% share of expenses). One of the parties should be appointed to write the payment checks from this account. Occupant owner's rent check should be paid directly to the non-occupant owner who will deposit this check into his personal account.

The SEFA should contain provisions generally present in all other types of co-ownership agreements, to wit: an ordering of how cash is to be paid upon sale or refinance of the property; no waste by the occupant owner; capital expenditure funding term; penalties for failure of either party to perform any duty under the SEFA; sale or other transfer to an outside party (not allowed generally); specific date when property must be sold, or no term certain; perhaps a right of occupant owner to buy out non-occupant owner at a certain date, and more.

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