Jan L. Warner & Jan Collins
Question: I am 47 and my live-in boyfriend of six years is 52. Both of us have been divorced, and neither of us wants to get married; but we do want to purchase a home together. Each of us works and is willing to contribute to the purchase price and make monthly payments. We went to a lawyer who told us that all we needed to do was to put the home in our joint names with a provision that the survivor would receive the share of the first of us to die. But we want to leave our shares to our children when we die. How can this be accomplished?
Answer: Buying the house may be relatively easy, but disentangling yourselves from the arrangement should your relationship terminate - or should one of you die - can be most difficult and expensive because the you do not have the remedies available to married couples. Despite the way the law may look at your relationship, when you purchase a residence together, you become "married" financially. That's why it's best to plan ahead, to design your remedies, and to try to avoid the many potential pitfalls through a "co-ownership agreement" at the time you purchase property.
Without a co-ownership agreement that clearly defines your intentions and mechanisms to resolve any disputes, you will be forced to depend upon expensive, yet inadequate, legal remedies that will probably not reflect your intentions. And since there are not automatic inheritance laws, you must plan for what will become of the property if one of you dies.
But not being governed by specialized laws and procedures can be an opportunity: You and your partner can plan now to anticipate future problems and create ways to avoid disputes.
Before you and your partner take title to a residence, you should understand that the way in which the property is titled can carry with it a number of unforeseen consequences. It is unwise to have title placed in the name of only one partner -- even for "tax purposes" -- because if that person sells the home and keeps the money, or dies and leaves it to antagonistic relatives, you could be in court for a long time and lose your investment. Therefore, the two types of ownership you and your partner should consider are Joint Tenancy and Tenancy in Common.
Because state laws involving marriage are based on the unity of a couple's life and assets, married couples often take title as joint tenants. In this way, neither owner can change the title without the consent of the other. And no matter what the deceased spouse's will may say to the contrary, the surviving spouse-owner will inherit the interest of the deceased spouse -- subject to outstanding mortgages and liens.
Joint tenancy can not be used, however, if the owners do not own the property in equal shares. While joint tenancy has its benefits for unmarried cohabitants -- like no probate upon the death of one partner, there are also drawbacks -- legal ramifications and difficulties should the relationship terminate by mutual consent.
In contrast, since the economic relationship of unmarried partners is not governed by state law and reflects "separateness" rather than combination of resources and obligations, tenancy in common is probably a better choice in most instances. As tenants in common, you and your partner have the right to name by will who inherits your share of the property. This means that if you die, your share of the property passes to whom you choose in your will -- subject to outstanding liens. And if you don't have a will, your share will pass to those members of your family who are automatically selected by state law. In other words, your co-owner partner has no self-operating right to your share of the property, not even a right of purchase -- that is unless this right is provided for in your co-ownership agreement.
For these and other reasons, should you decide to choose tenancy in common, you and your partner should make sure to deal with your estate plans because, if either of you dies without a will, the survivor may become a co-owner with members of the deceased partner's immediate family who may or may not have approved of your relationship in the first place. You may also want to discuss with your lawyer the benefits of using a revocable living trust before you make any final decisions.
APPORTIONING OWNERSHIP AND DIVIDING PROCEEDS
The way in which your property is titled can also be a method by which you and your partner apportion ownership and divide proceeds on sale. For example, if your comparative inital contributions and continued payments justify it, title ownership could be allocated sixty percent to you and forty percent to your partner. But, in many instances, this could lead to an unfair division of the sales proceeds, for example if you and your partner make unequal portions of the downpayment but pay equally toward mortgage payments, taxes, and maintenance -- or if there is significant appreciation in value. Even if you and your partner have made unequal contributions, dividing the proceeds can also lead to disputes. What this all means is that your plans and intentions should be clearly dealt with in a co-ownership agreement that addresses your intentions and the potential contingencies before the fact, not later when there are no options.
If you contribute all or the larger share of the down payment, here are two of the ways for you to be repaid when the property is sold:
You and your partner could agree that at the time of sale, each of you would first be reimbursed your contributions and the excess would then be divided equally. So, let's assume that A and B buy a home for $100,000. A puts down $25,000, B contributes $10,000, and they jointly take out a $65,000 mortgage. If they later sell the home for $150,000, under this scenario, A would receive $50,000 (the $25,000 down payment plus ½ of the $50,000 gain) and B will receive $35,000 (the $10,000 down payment plus ½ of the $50,000 gain). The problem here is that by simply refunding the initial contributions, B will receive the same gain on a $10,000 investment as A will on $25,000 -- and A will lose the appreciation attributable to A’s greater contributions.
Another alternative would be for A and B to agree to divide the sales proceeds in the same percentages as their initial contributions. Since A's contribution to the downpayment under this example was 71 percent, A would receive $60,350 (71% of total equity) and B would receive $24,650 (29% of total equity). But there is also a problem here: If A and B equally paid the mortgage, taxes, insurance, and maintenance payments, B would come up short.
As you see, using either method brings with it both plusses and minuses. That's why some people develop their own formulas to try to factor in the actual contributions and appreciation. But when you begin to consider improvements to the property, the calculations become even more difficult. For example, what if, in addition to making the downpayments, A and B each paid in $7,500 toward property improvements? In this case, what part of the gain results from the down payments and what part from the improvements?
And there are still other considerations: What if you and your partner agree to contribute equally to all payments and repairs, but one of you does not comply with the agreement? Are there circumstances under which you and your partner would want iniital unequal ownership to ripen into equal ownership? How will you handle it if a third person - like one of your parents - helps by putting up money for the downpayment, but does not live there? And if the property is sold for a loss, will you and your partner share losses in the same way you share profits?
PAYING THE MORTGAGE, INSURANCE, TAXES, REPAIRS, AND UTILITIES
Some mortgage payments consist of principal and interest, while others also include taxes and insurance. Either way, a co-ownership agreement should provide that you and your partner will each pay one-half - or whatever percentage you agree upon - of the complete payment each month by the due date. If there is no escrow for taxes or insurance, you and your partner should open a joint account -- requiring both signatures -- into which each of you should deposit each month agreed shares of the taxes and insurance so that when due, you the funds will be there to pay these obligations.
But the basic assumption that you and your partner will pay your shares of the mortgage payments each month -- not to mention taxes, insurance, utilities, and repairs when due -- may be ignored if a dispute results in one of you moving out and beginning to pay rent or mortgage payments somewhere else. Under these circumstances, it may be tempting for the vacating partner to ignore his or her obligations, thereby leaving the remaining partner to carry the entire burden in order to continue living in the property.
For these reasons, the co-ownership agreement should contain very specific provisions that will deter the vacating party from ignoring these responsibilities. Penalty provisions - meaningful late fees and interest on payments not made on time - should constitute a lien on the vacating party's interest. And if the required payments are not made for say six months, then consider including a provision by which the vacating partner's interest in the property would be forfeited, thereby allowing the remaining partner to rent or sell the property and keep all of the equity.
WHO PAYS TO MAINTAIN THE RESIDENCE?
An agreement between you and your partner to pay the necessary maintenance expenses in agreed shares could be more difficult to enforce than you might think. How you and your partner define "necessary" is the key. Repairs to the air conditioner, furnace, water heater, and roof, for example, are clearly "necessary," while planting grass and bushes, wallpapering, painting, and putting down new carpet are more voluntary than required.
In order to avoid future disputes, you should not only clearly define what will be done and when, but also who can authorize the work, how the bills will be paid, and in what percentages.
RENTING THE RESIDENCE
What if, in our example, A moves out and B can not afford to continue to live there without financial assistance? It might be necessary for the property to be leased in order to defray the monthly mortgage payments and other expenses or for B to bring in a boarder to share expenses. Without a prior written agreement between the A and B, this remedy will be difficult, if not impossible. That's why your co-ownership agreement should contain rental provisions including approval of tenants, accountings, and related matters. If the vacating partner is not making payments as called for, the remaining partner should be allowed to make all rental decisions, to collect all rent, and to sign leases and other legal documents.
OPTIONS TO PURCHASE AND SELL -- AND RELATED ISSUES - DURING LIFE
Since the property you and your partner purchase will someday be sold for one reason or another, your co-ownership agreement should contemplate that event and its many nuances. If you and your partner both decide to sell the property at the same time, there should be no problem since both of you will have the same goal: To obtain the best price for the property.
But if only one of you wants to sell, the problems begin: On one hand, the partner who wants to sell his or her interest should not be precluded from disposing of that interest and receiving his or her equity in the property. On the other, however, the partner who wants to continue owning the property should be able to continue and not be forced to sell off his or her interest. That's why it is best to deal with this issue at the time of purchase in a written agreement when neither partner will be able to predict which will want to sell in the future.
Again going back to our example, let's see a few ways in which A and B can set the purchase price:
A and B could establish a price at the date of purchase and agree to annual increases (or decreases) in value. Since most owners are inexperienced in valuation matters, this is probably not a good idea.
A and B could agree to be bound by the opinion of an independent appraiser who is acceptable to both and whose fees will be paid by them in equal shares. If they can't agree on an appraiser, they might agree that a disinterested person -- say, their mortgage lender or banker -- will choose the appraiser by whose opinion they both will be bound.
Once the purchase price has been set, the next step is to decide what the buying partner will pay to the selling partner for his or her equity interest. Assuming that the seller owns 50 percent of the property and is up-to-date on all required payments, the following might help establish the amount the seller should receive for his or her equity:
First, add to one-half (½) the established sales price the following amounts: One-half (½) of the escrow balance on deposit with lender, one-half (½) of the prorated, prepaid insurance premium, and one-half (½) of the balance in any common real estate account that has been established by you and your partner.
Then deduct the following: One-half (½) of the outstanding mortgage principal balance, one-half (½) outstanding taxes prorated to date of sale, one-half of outstanding utilities and maintenance expenses, and one-half (½) of interest to be paid with the next mortgage payment prorated from the date of sale to the due date of that payment.
If the selling partner has not paid all agreed obligations, or has made the payments late and penalties and interest have accrued under the co-ownership agreement, then these charges should also be subtracted from the selling parnter's share. And if judgments or other liens have been filed against the seller, these amounts should likewise be deducted and paid to the creditors who, otherwise, will continue to have a lien against the property after the sale.
After the price has been established, since it will take time to secure the funds required to conclude the buyout, the purchaser should have at least 60 -- and probably 90 days -- to exercise the purchase option.
Last, but certainly not least, the purchasing partner should be required to either 1) arrange to have the selling partner released from the mortgage or 2) obtain alternative financing by which the original mortgage will be satisfied. It should not be acceptable for the selling partner to have continuing liability on a mortgage after the sale of the residence, especially since most lenders will consider this liability when assessing the selling partner's creditworthiness for obtaining a future loan.
But getting the mortgage company to release the selling partner from the note and mortgage may be very difficult, if not impossible. Going back to our example, A and B used your combined credit to qualify for the mortgage and their combined incomes to make the payments. With A leaving, there will be a drastic drop in available income, often to the extent that B will probably not be able to qualify for a loan at the time of the buy-out if B applies alone -- that is unless the property is a duplex or other multi-family dwelling and rent from other unit(s) may be enough to offset the loss of the A's income.
If the B can not handle the financial burden of the buyout alone, A might agree to a contract of sale or a second mortage that will be satisfied with monthly payments. But this too is dangerous for a number of reasons: B might stop making payments, declare bankruptcy, or allow the property to depreciate. If this method of buyout is being considered, it is a good idea to consider requiring B to get the personal guarantee of a financially stable stable third parth to protect A.
OPTIONS TO PURCHASE AT DEATH
If one of the partners dies, the survivor should have the option to buy the interest of the deceased from his or her estate on the same terms we have discussed. Because the purchase might be made from an estate (depending on whether or not there are valid wills), the surviving partner may need more time to complete the purchase. If the surviving partner does not exercise the option to purchase, it is a pretty good bet that the property will be sold because the estate and heirs will probably not be interested in assuming this obligation.
Because a conflict between you and your partner may arise in the future, you will want to plan today for the way in which it will be resolved. Overburdened, underfunded courts are places where your private business becomes a matter of public record. In these types of matters, the court may not be the best place to resolve your controversy. That's why you should consider building into your co-habitation agreement a provision calling for "Alternative Dispute Resolution" to resolve your differences. ADR consists of a number of methods by which you can choose to resolve problems that would otherwise end up in court. Let's look briefly at two of these techniques:
1. Mediation is where a neutral third party tries to help you and your partner reach your their own settlement. The mediator has no authority to force a binding final determination and the mediator's decision cannot be enforced in court.
2. Arbitration is where one or more neutrals are selected, hold private hearings, and render either a final and binding decision that is enforceable by court judgement or a non-binding decision that is not enforceable in court.
Because of the complexities of the questions involved, the ways in which you may choose to resolve any differences that arise, potential tax considerations, and other issues that are not covered here, it is always a good idea for you and your partner to seek the assistance of competent attorneys who can help you prepare a co-ownership that expresses your intentions and protects both of you.