Real Estate Cover Story.

It's a win-win. The only loser is the IRS, and don't you just love that?

EQUITY SHARING PUTS PEOPLE INTO HOUSES WHILE GIVING INVESTORS A CHANCE FOR PROFITS

By Julie Clairmont
Special to the Mercury News

The down payment, for some, is a seemingly insurmountable brick wall between them and the American Dream of owning their own home.

This is especially true in expensive California real estate markets like Santa Clara County, where the median price of a single-family home hovers around $475,000, meaning a home buyer would need $95,000 for a 20 percent down payment.

The ironic thing, says Larkspur attorney and real estate broker Marilyn Sullivan, is that it doesn't have to be like that.

Sullivan is a nationally recognized expert on equity sharing, an arrangement in which investors supply the down payment and the buyer-occupant lives in the house and pays the mortgage. At the end of a specified term -- Sullivan recommends seven years -- the home is sold. The investors and occupant split the equity, usually 50-50, and go their separate ways. The sale could be to a third party, or the occupant could refinance the property and buy out the investor.

``The goal is for the occupant to have a tax deduction, realize some appreciation and, when it's over, be able to get rid of the investor,'' says Sullivan, author of a book on the subject, ``The New Home Buying Strategy.''

If the investor and occupant choose a property that is a solid investment, both parties benefit, says Sullivan. The occupant becomes a homeowner without a down payment, and the investor makes a return on their investment. On top of that, both parties receive tax benefits from owning the home.

Darren Story, a San Francisco options broker, and his brother, Eric Story, a Safeway manager, used equity sharing recently to buy a $680,000 home in the Crocker-Amazon area of San Francisco, near the Cow Palace. Their father, Stephen Story of Catalina Island, was the investor, coming up with 15 percent of the 20 percent down payment for the mortgage loan.

Problems typical

Darren, 30, and Eric Story, 25, are typical of many Bay Area residents: well-paid with good jobs and strong credit, but finding it difficult to come up with the large down payment needed to purchase a home here.

Equity sharing ``is a great opportunity for both parties,'' says Darren Story. ``It was a good way for my dad, who was pretty hard-hit in the stock market, to balance out the risk in his portfolio and, at the same time, help his kids out.''

There are different ways to structure an equity sharing deal, and the tax benefits depend on the agreement. Using Sullivan's formula, the investor would use rent paid by the occupant to pay for homeowners insurance and homeowners dues (if any) -- both of which are tax-deductible for the investor.

The investor and occupant both get to deduct the property taxes; if the ownership agreement is 50-50, they would each get to deduct half. The occupant also gets to deduct the mortgage interest. The investor can also depreciate their share of the rental property.

``It's a win-win,'' says Sullivan. ``The only loser is the IRS, and don't you just love that?''

How it works

Using a $400,000 home as an example, Sullivan explains how one equity sharing model works:

• An investor or investors supplies an $80,000 down payment -- 20 percent -- and the occupant pays the $2,000 mortgage payment each month plus rent to the investor.

• The two parties agree to a 50-50 split in ownership and take title as tenants in common.

• Assuming 10 percent annual appreciation, the house would be worth $779,000 after seven years. Assuming a loan balance of $295,000, equity in the home would equal $484,000.

• The house is sold, the investor gets the $80,000 down payment back, and the occupant receives the $25,000 in mortgage principal they have paid. That leaves $379,000 for the parties to split, without taking into account realty agent commissions or other sales costs.

• Additionally, the occupant-buyer has been deducting mortgage interest over the seven years, and both the occupant and investor have been deducting a portion of the property taxes.

• The investor could reinvest their share of the proceeds in another rental property through a tax-deferred exchange, she says.

In Sullivan's example, the title is held as ``tenants in common,'' but title can also be held in joint tenancy with the right of survivorship, partnership, or a living trust. However, all parties must hold title.

If the property has not appreciated during the term of the contract, the parties could agree to an extension. Some contracts have a clause that provides for automatic extension if the property has not gained in value.

Low risk

Ken Gervais, owner of Triangle Realty in San Jose, says there are few risks to equity sharing, if it is done thoughtfully.

``Anytime you have a someone buying something with very little money invested, you run a higher risk that they will default,'' says Gervais, who has been in business for 10 years.

``But that's why we look for occupants with excellent credit.''

For the occupant, the time factor may be a problem, says Gervais, who recommends a five-year equity sharing term. Through his program, occupants can rent out the home if they need to. In most cases he has seen, buyers have opted not to purchase the home at the end of the contract. ``After five years most people are ready to move on,'' he says.
Triangle Realty matches occupants and investors for equity sharing and also will help would-be occupants find a house.

Gervais says making offers on homes using equity sharing financing, even in a seller's market, is not difficult. The trick, he says, is for the occupant to get all of their financing in place before they make an offer.

The biggest challenge of equity sharing may be finding an investor or investors. Amy and Todd Mezullo of Sebastopol, for example, feel they would be ideal occupants in an equity sharing arrangement. ``We've got good credit and income, we're upwardly mobile, we've been paying rent on our town home for the past eight years,'' says Amy Mezullo.

The Mezullos, who would like to buy a home in Santa Rosa, closer to Todd Mezullo's job, are hoping to find an investor who will see them as a good risk. The couple has posted their names on a bulletin board on Sullivan's Web site hoping to hook up with an investor.

While Sullivan has overseen about 1,000 equity-sharing deals over 17 years, she says it's a home-buying tool that is most used within families, specifically for parents helping children.

Sullivan suggests home buyers interested in equity sharing consider approaching family members and friends and asking them to invest $2,000 or $3,000 each until there is enough money for the down payment. She also recommends they learn how to explain the benefits of the investment, particularly the possible appreciation benefits of investing in California real estate.

Would-be home buyers interested in equity sharing might also try contacting realty agents, accountants, attorneys and other professionals who might know an investor.

While equity sharing can be mutually beneficial for investors and occupants, financial experts recommend using a real estate attorney who understands equity sharing agreements. Do not attempt to draft the contract yourself, they say.

Some tax professionals recommend against equity sharing agreements with strangers, saying this tool works best for parents who want to help their children get into a home.

EQUITY SHARING
For more information about equity sharing in buying homes:

• Marilyn Sullivan offers a free seminar on equity sharing on the first Tuesday of every month, 6 to 7 p.m. at Bank of America, 1000 Fourth St., San Rafael. Reservations by calling (415) 461-1444 or going on the Web at www.msullivan.com

• Sullivan has written a book on the subject, ``The New Home Buying Strategy,'' that is available at Amazon.com. ($24.95, McGraw Hill).

Equity sharing can benefit investors, first-time buyers

Judy Richter - Real Money

It's no secret that buying your first house in the Bay Area is difficult.

Even if you have a good income and can make hefty mortgage payments, it's hard to save a 10 or 20 percent down payment when starter houses are going for $400,000 or more.

One way around this quandary is an investor-occupant arrangement called equity sharing. In such an arrangement, the investor supplies the down payment but doesn't live in the house.

The occupant lives in the house, pays the mortgage and agrees to give the investor an ownership interest - usually 50 percent - in the house.

To satisfy Internal Revenue Service requirements, the occupant also pays the investor rent in proportion to the investor's ownership share, said Marilyn Sullivan, a Larkspur attorney who specializes in equity sharing contracts.

In turn, the investor claims his share as rental property and is entitle to the tax benefits that go with it.

Sullivan cited a theoretical $00,000 house for which the investor supplies the $80,000 down payment and the occupant pays the $2,00 monthly mortgage payment. They agree to a 50-50 split in ownership and take title as tenants in common.

Using formulas and software that she has developed, Sullivan said the occupant would pay the investor $640 a month in rent.

The investor uses that rent to pay expenses in this order: homeowner insurance, which is tax-deductible for him but not for the occupant; homeowner dues, if any, which also are tax-deductible for him but not for the occupant; and whatever is left for property taxes, which are deductible for both parties.
The investor also can depreciate his share of the house as rental property.

"In the long run, the occupant loses 1- to 15 percent of the deductions" that he would get if he owned the house alone, Sullivan said.
However, the investor has used the rent to pay expenses that the occupant would ordinarily pay, and the occupant still gets tax deductions that he wouldn't have had as a renter.

The arrangement usually continues for a set number of years, after which either party has the right to buy out the other.

If neither one wants it and they decide to sell the house, they split the proceeds.

Again citing that $400,000 house, Sullivan assumed that it appreciated 10 percent a year and sold for $779,000 after seven years.

She also assumed that the loan balance is $295,000, leaving and equity of $484,000. From that amount the investor is entitled to his $80,000 down payment. The occupant is entitled to the $25,000 in mortgage principal he paid over the years, leaving $379,000 for them so split equally. That's $189,000 each before the sales costs are paid.

Besides walking away with that cash, the occupant has deducted a total of $169,000 in mortgage interest over the seven years. The investor has received $30,800 in rent but has applied it to other costs, which he has deducted.

Furthermore, because his share was rental property, the investor can reinvest in another rental property -
called a tax-deferred exchange - and not pay taxes on his share of the sales proceeds, Sullivan said.

Equity sharing can be an excellent real estate investment because the occupant has an ownership stake and a strong incentive to make the payments and maintain the property. Even if one part reneges on the deal, the other can foreclose.

Sellers confronted with a slow market might offer to do an equity-sharing arrangement to help sell their houses.
Many parents see equity sharing as a good way to help their children buy a house. Moreover, they can gift a portion of their investment to the child or children each year. "It's a good estate reduction tool," Sullivan said.
However, equity sharing also can be done by strangers. Some people put ads in the paper looking for investors or occupants.

One of the most important factors in equity sharing is to choose a house that has a good chance of appreciating, Sullivan said.

It's also important to remember that this is a business deal even when family members are involved. Therefore, it's crucial to have a written contract that spells out all aspects of the finances as well as contingencies such as death, bankruptcy or liens.

Sullivan has written two books about equity sharing: "The Complete Guide to Equity Sharing" and "The New Home Buying Strategy."

She also teaches a free seminar about equity sharing the first Tuesday of every month from 6 to 7 p.m. at the Bank of America, 1000 Fourth Street, San Rafael. Reservations may be made at 415-461-2311 or www.msullivan.com.
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E-mail Judy Richter at
jrichter@sfchronicle.com