How to structure an equity position?

3 Replies

Hi folks! Looking for some advice. I am purchasing a property and only have half the money required for the downpayment. My parents are going to contribute the other half. My husband and I qualify for the loan ourselves, so they will not be on the mortgage and we are showing their contribution as a "gift" to the lender. 

My parents don't want to structure it as a loan because they do not want any more income or to be put in a higher tax bracket. Therefore, we've agreed to split the appreciation growth of the property (with full disclosure that this is speculative, but we believe we are in an appreciating market). We don't want to split the equity growth because we'll be the ones servicing the debt and paying down the mortgage, thereby creating more equity as time goes on. 

A few questions:

1. If we are the ones paying 100% for improvements to the property that creates appreciation (i.e. redo the kitchen or bathrooms), how do we account for this?

2. How should we structure this legally? Do we record this in some way on the title, or create some sort of side agreement? 

3. What are some options for their ability to request repayment of their contribution plus their portion of the appreciation? Ideally, this will be a long term buy and hold property (and the money contributed by my parents would eventually become part of our inheritance anyways), but they want assurance that in the case of some medical emergency or time of need in the future they could get the money back? 

4. We have negotiated a purchase price that is $100K less than the appraisal came back at, so we have $100K of equity in the property, plus our 20% downpayment from the start. Do my parents automatically have 50% of the total equity at the start, or only future appreciation above the appraised value?   

Any advice or thoughts would be greatly appreciated! TIA. 

@Megan Lawson

Conventional lenders do not like seeing "gifts" from outside parties.
They will ask for 2 months worth of bank statements and flag any incoming deposit that looks fishy.

From the lender's eyes, if you can't come up with the 20% downpayment, you may have trouble coming up with the monthly mortgage payments which means its a risky loan.

It looks like you are trying to create a partnership or a joint venture with your parents. You may need to look for a portfolio lender to lend in this scenario. 

Not exactly the advice that it sounds like you're seeking, but mine is to not get into any sort of business with family at all.  Disagreements could happen down the line on the specifics, and contract or not, the need for money destroys relationships every day.

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@Megan Lawson It sounds like you want to split capital gains with them. Capital gains would be future sale price minus purchase price and capital improvements like redoing the kitchen. Example you pay 100k now invest 20k in renovations and sell in 10 years for 150k. Capital gains would be 30k I think this is what you are trying to split correct me if I am wrong. 

1. You should keep track of all expenses that improve the property since you can use them to reduce your capital gains tax when you sell. How you track them could be scanned receipts in a folder and a spreadsheet or something more sophisticated but track them. 

2. As for structuring it, I would have an attorney draw up an agreement. If you want to go one step farther you could have the agreement recorded at the county as an affidavit.

3. Options for getting their cash back with capital gains is tricky. The way you appear to be wanting to structure gives 3 options. 1)sell 2)cashout refi 3)come up with what you owe them and pay them yourself. but you will want to define what you would do in this case ahead of time and put it in your contract. 

4. If you go the route of splitting capital gains then yes they would be entitled to 50% of the difference between purchase and sale price if you could sell it for what it is appraising for. 

Now for some unsolicited advice. I am of the thought that doing business with family is not for everyone and more specifically not for everyone in my family. I do business with my father and we're able to be honest and direct with one another about our perception of things and discuss business without allowing it to be tied to emotions. I have other members of my family that I would not be able to be so formal and business-minded with. 

With that said you need to have open and direct dialogue with everyone involved. Talk about all the different situations you can think of and decide now how it will be handled in the future. Everyone needs to agree to the terms of the deal. Money can and will ruin relationships if the specifics are not discussed and documents ahead fo time. If anyone thinks that this could cause an issue in the relationship then find another way. Family is more important than money. 

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