What you learned in kindergarten about sharing could help in your quest for a first or second home. But this time around, rather than sharing your Lincoln Logs, you’ll be sharing your home, with a co-buyer. (By the way, the son of famed architect Frank Lloyd Wright was, ironically enough, the creator of Lincoln Logs.)
Once the domain of married or committed couples, more and more home buyers are discovering the advantages of teaming up with a relative, friend, or someone else to buy a house. This is particularly true of second-home buyers looking for an investment or weekend getaway.
Rather than shoulder this debt burden on your own, you can partner financially with someone similarly interested in owning a home. If done right, the shared-purchase approach can get you a home you might not otherwise have been able to afford. One the other hand, if you don’t fully think through the arrangement and set it up correctly, it could lead to financial and legal chaos, not to mention a strained or broken relationship.
Co-Ownership Options for Holding Title
Any time you buy a home, you receive what’s called title, evidenced by a piece of paper called a deed. The deed will contain a legal description of the property, identify who is transferring an interest in the property (the grantor) and who is accepting it (you and your cobuyer, the grantees), and explain how the grantees are sharing the title.
Your main options for sharing title include:
- as tenants in common (TIC), and
- as joint tenants with right of survivorship (JTWROS).
Married couples may also take title as tenants by the entirety or in the form of community property; however, those topics aren’t discussed further in this article, on the assumption that your co-buyer is someone more distant.
Legally, many similarities exist between a tenancy in common and a joint tenancy. Both give each of you what’s called an undivided interest in the property, meaning you can both use and enjoy the entire property and, in the case of a second home, you’re both entitled to rental income from the entire property in proportion to your ownership share. In either case, if one of you wanted to sell, that person couldn’t simply divide the property in half and sell it he or she would instead have to sell his or her tenancy or interest in the property. The buyer would gain the same rights as the seller had.
Another similarity between TIC and JTWROS forms of title is that both give each owner the so-called “right to partition.” This means that if one co-owner wants out, but can’t reach an agreement with the other co-owner or can’t find a third party willing to buy a partial interest in the property, the one who wants out can go to court and force the tenancy to be dissolved. The assets are then distributed to each co-owner. A partition action, which usually involves an attorney, can drain your time and money. Therefore, it should be used only as a last resort. You can help avoid the need for a partition action by creating a co-ownership agreement (discussed below).
There are also some important differences between a tenancy in common and joint tenancy, particularly when it comes time to sell or dispose of one person’s ownership interest.
Holding Title as Tenants in Common (TIC)
A tenancy in common (TIC) is by far the most common way for unrelated co-buyers to take title. Despite the unlimited rights of access and usage, you and your co-buyer are allowed to own unequal interests (also called shares) of the property. Each of you can sell or transfer your ownership interest without getting consent from the other owner. Also, if one co-owner dies, his or her share is transferred to the beneficiaries of the estate.
Holding Title as Joint Tenants with Right of Survivorship (JTWROS)
Co-buyers who are related often choose to take title as joint tenants with right of survivorship (JTWROS). With this form of ownership, you and your co-buyer have no choice but to own equal interests in the property, 50/50. If you buy a home with two other partners, you each own a one-third interest, and so forth.
Unlike with a tenancy in common, upon the death of one joint tenant, the remaining owners gain the deceased owner’s interest in the property. This happens automatically, no need for a court or probate proceeding. In fact, even if the deceased owner wrote a will specifying that the property was to pass to some other person, that request will not usually be allowed.
Talk is cheap and what’s worse, easily forgotten later. That’s why you need to draft and sign a co-ownership agreement. This document explains how you and your co-buyer plan to deal with various potential issues, thereby helping head off confusion or misinterpretation down the road.
The most challenging part of drafting a co-ownership agreement is anticipating issues while everything looks rosy. Most individuals enter into a partnership with the friendliest of intentions, thinking they can work out any unforeseen questions later. But with big dollars and possibly your leisure or retirement time at stake, fundamental disagreements can arise and be tough to work out.
Co-ownership agreements can range from short to lengthy. The advantage of a longer agreement is that it allows for more potential issues to be covered, which can make the agreement more effective should a problem arise. However, regardless of length, the agreement should at least address the issues discussed below.
Who Owns What Percentage?
You don’t need to draw a line down the center of the house, but you do need to clarify what percentage of it each of you will own. This is especially important in case one of you later dies or decides to sell his or her interest.
This decision is easy if you take title as joint tenants with right of survivorship (JTWROS) you divide your interest in equal parts, such as 50/50 if there are two of you.
If you take title as tenants in common (TIC), however, you don’t need to divide your interests 50/50, nor even on the basis of how much money each of you puts in. For example, the two of you might decide that one will receive a greater percentage because he or she agreed to manage upkeep on the property.
Another possibility is that one co-owner contributes less for the down payment, but shares equally in paying ongoing expenses such as mortgage payments, property taxes, and utilities. The owner who contributed less towards the down payment might agree to a lesser percentage of ownership (or, you could come to some other arrangement, such as a long-term loan). It’s all up to the two of you to negotiate according to what you think is fair.
How Do Co-Owners Allocate Ongoing Expenses?
Expenses may include mortgage payments, property taxes, insurance premiums, utilities, and other costs associated with maintaining and operating your home. Your co-ownership agreement is one of the few, if not the only, places in which you can specify how to allocate these expenses between you and your co-owners.
Following are several allocation options:
- Mirror ownership allocation. Many co-owners simply allocate costs at the same percentage as ownership. For example, if you own 60% of the home and your co-owner owns 40 percent, then you would cover 60 percent of the expenses and your co-owner would cover 40 percent. This approach works particularly well for TIC titles, since ownership can legally be allocated unequally. However, anything other than a 50/50 split won’t work for JTWROS titles, in which ownership can only be allocated equally, regardless of time and money contributions.
- Use down payment allocation as a guide. This approach uses the down payment contribution of each co-owner as the foundation for determining expense allocation. For example, if the total down payment on a home is $100,000, and you contributed $55,000 while your co-buyer contributed $45,000, then you would cover 55% of the expenses and your co-buyer would cover 45 percent. Because ownership allocation isn’t an issue, this approach works well for either TIC or JTWROS titles.
- For Second Homes: Apply a personal usage-based allocation. If you and your co-owner plan to buy a second home and use it personally (as opposed to renting it out), then another approach could be to allocate expenses based on the amount of time each co-owner uses the home. For example, if the home is used a total of 13 weeks out of the year, eight by you and five by your co-owner, then you would cover 62 percent of the expenses and your co-owner would cover 48 percent.
What Happens If One Co-Owner Later Wants Out?
If you own a house by yourself, you can of course sell it whenever you choose without consulting anyone. But if you co-own it, getting out of the deal may not be so simple. Neither of you probably want the other one to be able to sell his or her interest to any old third party (assuming there’s even a market for a partial interest in a house). But that’s exactly what can happen, because regardless of whether title is held as TIC or JTWROS, each co-owner does not legally need the other’s approval to sell his or her interest in the property.
One way around this issue is to have a provision in the co-agreement that gives the co-owner who’s staying a right of first refusal to purchase the selling co-owner’s interest. However, even with this provision, there are still several questions the co-ownership agreement will need to address:
- How will you fairly assess the property’s value? In a buyout situation, the co-owner purchasing the departing co-owner’s interest wants to make sure he or she isn’t paying too much. On the other hand, the selling co-owner wants to make sure he or she is receiving fair market value for the interest. To minimize potential problems, the agreement should stipulate how the property will be valued. The most common and least expensive way it to use a licensed home appraiser to determine the current market value of the property. The actual buyout amount could then be determined based on percentages of ownership interests. Keep in mind that if title is held as JTWROS, the interest is 50 percent regardless of the amount the selling co-owner contributed.
- Does the selling co-owner have to accept the buyout offer? In most cases, the answer is no. Allowances are usually made for the selling co-owner to have a change of heart. For example, he or she may realize that the interest in the property isn’t worth as much as expected. The co-agreement should leave room for this.
- What if the remaining co-owner can’t come up with sufficient funds? The co-ownership agreement could contain language that would allow him or her to find a replacement co-owner who would purchase either 100 percent of the seller’s interest or a fractional amount in conjunction with the remaining co-owner. Most agreements will specify a maximum amount of time to find a new co-owner.
What Happens If a Co-Owner Buys the Farm?
Not to be confused with the actual purchase of a farm, we’re talking about the arrival of the Grim Reaper here. You and your co-buyer need to decide what would become of the portion of the property owned by one of you if you died. Does it go to the surviving co-owner, to the deceased person’s heirs, or to someone else? While the type of ownership structure you choose in your title deed will largely take care of this, it’s not a bad idea to reinforce your choice in the co-ownership agreement. Heirs have been known to contest deeds and win a court ruling in their favor.
Sharing the purchase of a home can significantly reduce your debt burden. However, you should thoughtfully and carefully decide whether sharing homeownership makes sense for you as well as your potential co-buyer.