Selling 1/2 interest (rental) in townhouse to co-owner (residient)
Two sisters bought a townhouse-both paid 1/2 of down payment. One lives in the townhouse and the other collects rent from her sister for her half. The resident claims 1/2 the mortgage, taxes, etc. as homeowner, the other treats her half as rental property, claims 1/2 motgage, taxes, maintenece, etc as deductions for rental property, claims rental as income and takes depreciation every year. After deveral years they want to refinace and the resident sister was "advised" to buy her sister out when they do. The resident sister would refinance for enough extra to pay her sister back her half of the down payment and they want to agree that when the resident sister eventually sells the house in the future that she would pay her sister half of the profits based on the Fair Market Value today or the price she sells at in the future, whichever is the highest profit. Sounds like an "installment sale" except the IRS code looks like you can't do an installment sale with a relative on property that was depreciated.
Any strategies so that the sister who had used it as a rental property doesn't have to claim the sale now since she's not getting the money now? She probably does have to recapture the depreciation now.
If no stragies are evident what type of expert should they see to make sure it's done right?
Either the property is sold or it is not sold. If the property is sold to the resident sister now, the non-resident sister has a taxable event that must be reported on her next tax return. She just can't wait until the property is sold again.
As far as I know, installment sales between related parties are perfectly acceptable. But, I don't think an installment sale is needed. Here is how I might structure a simpler approach for this one.
1. Have the resident sister apply for an 80% cash-out refinance loan in her name only. The lender will order an appraisal to establish a reasonable market value.
2. Use the net proceeds from the refinance to purchase the non-resident sister's equity in the property.
An illustration. The property was purchased for $100K and is now worth $150K. Each sister owns half of the property, and would be willing to sell her half to the other for $75K. Let's say that the property was originally purchased with 90% financing and still has $80K left on the loan. Subtracting the loan balance from the market value, gives each sister $35K equity in the property.
An 80% refinance will generate $120K with $40K left over after the underlying mortgage is paid off. Since only $35K is needed to buy out the non-resident sister, the remaining $5K can be used for closing costs -- meaning noone needs to bring money to the settlement table.
The non-resident sister gets her profit now, and either reports a taxable event or does a 1031 like-kind exchange to defer her capital gains taxes. The resident sister gets 100% financing with no out of pocket expenses.
Now these numbers just seemed to work out. If the situation in the sisters' case does not allow a refinance to completely purchase the other sister's equity, then the buyer just gives the seller a second mortgage for the portion of the equity that is still owed. The non-resident sister reports an installment sale and only pays capital gains as her profits are received.[ Edited by DaveT on Date 02/11/2003 ]