Sometimes when an unmarried couple decides to live together, one partner already owns a house and the other partner moves in. When this happens, issues of property ownership and how to deal with expenses inevitably arise.
In some cases, the person moving in simply agrees to pay half (or some other agreed-upon portion) of monthly expenses, (mortgage payments, insurance, taxes, and the like)—putting off the decision to share ownership until both partners gain confidence that their relationship is likely to endure.
In other situations, the couple decides that the person moving in will become a co-owner by paying the original owner for half of the property’s equity. This can be done in one lump sum or by paying the existing owner in monthly installments (under a separate promissory note). Whatever your agreement, you’ll want it in writing, spelling out all the financial details, such as the fair market value of the house, how you will share ownership in the property, and how and when the person moving in will make payments to the current home owner. See the Sample Agreement for One Person to Move Into the Other’s House and Become an Immediate Co-Owner included here for a model in preparing your own agreement. For advice on the general clauses included in house ownership agreeements, see the article Contract for Equal Ownership of a House by an Unmarried Couple included on this site.
If a nonowner is going to contribute to his or her partner’s residence and never become an owner of record, we strongly recommend having a written agreement clarifying whether or not the nonowner will receive any share of the appreciation, or will simply be considered a renter.
If you decide to sell a share of your house, spend some time with a tax accountant and real estate attorney unless you are totally confident that you understand all the tax and legal issues involved. The rules for a partial buyout by an unmarried partner are a bit murky, so if a lot of equity is involved, check with an accountant or a tax attorney. See Nolo’s Lawyer Directory for a list of local real estate and tax attorneys.
Check out the tax consequences. If you receive no money from the sale of an interest in your house in a particular year, there is normally no taxable gain or income to report from the sale; but it may be considered a gift, which can have long-term estate tax consequences for the donor. If you do receive money from the sale, you have to determine what percent is a return on your initial capital (not taxed) and what percent is interest and profit (which may be subject to a tax if the house has a great deal of value). However, federal tax law now provides that if the house has been your residence for at least two of the last five years before the sale, the first $250,000 in capital gains received by each partner is not taxed. In some states, you also may have to pay a transfer tax or increased property taxes. For information on tax laws involving real estate transactions, see IRS Publication 523 on the IRS website; this specifically covers tax issues when selling your house.
Beware of the Due on Sale Clause. If you sell a share of a house already subject to a mortgage or deed of trust, you may need lender approval under the terms of a “due on sale” clause. Most real estate mortgages contain a due on sale clause that requires that the borrower pay off the entire mortgage before selling the property, unless the lender approves the sale without full payment of the mortgage. The lender may not approve for a variety of reasons, especially if your fixed rate mortgage interest rate is below the current market rate, but many lenders do not enforce this clause at all. This may mean you’ll need to pay off the existing mortgage and refinance. Or it may cause you to rethink the wisdom of the entire transaction. For example, you might decide not to change ownership at all, but instead use the other partner’s money to purchase other assets that would remain in his or her name, but be used to benefit both partners.
Where one member of a couple is more affluent than the other, the most realistic approach for many couples is to draft an agreement that allows the person moving in to become a co-owner gradually. Although there are a number of ways to do this, the most common is to provide that each month the person moving in will pay a portion—or, possibly, all—of the monthly mortgage cost in exchange for receiving a tiny equity share in the house. See the Sample Agreement for One Person to Move Into the Other’s House and Become a Co-Owner Gradually as a model in preparing your own.
There is no correct way to determine how much the gradual co-owner must pay before he or she becomes a half-owner of the home. Many factors come into play, making the calculation tricky. For example, the value of the home probably will fluctuate during the time period when payments are made. The more the original owner has already paid, the more the gradual co-owner will have to pay. The length of the mortgage will factor in too. And finally, part of the gradual co-owner’s payment will go towards interest, not principal—making the interest rate important as well.
There are several options to determine the amount the gradual co-owner must pay before owning a half interest in the home:
• Some couples ignore all of the above factors and decide that the new owner simply must pay an amount equal to the original owner’s current equity.
• Some couples decide that the gradual co-owner must pay more than the original owner’s current equity, perhaps 25% or 50% more, based on an estimate of long-term appreciation. Couples that follow this approach do so on the theory that money already invested is worth more than money to be invested in the future. And, the fair market value of the house is likely to increase over time.
• Another approach is to consult an expert in real estate finance who is familiar with the local market, and get an opinion as to what would be a reasonable amount.