One solution: Enter into an equity-sharing arrangement with your child. As the name implies, you share the ownership rights but you keep the lion’s share of the tax breaks. After a specified period, you sell your interest in the home to your child.
With this arrangement, your children can gain a foothold in the housing market. At the same time, you can claim the top-dollar tax deductions treasured by high-income parents. Everyone but the tax collector wins!
Equity sharing in action. Let’s say your daughter is marrying in June and wants to buy a house. Unfortunately, she and her fiancé can’t afford the home they have their hearts set on. So, you agree to buy 50 percent of the home through an equity-sharing arrangement.
For starters, you pay half of the down payment for the home and the young couple pays the other half. You also agree to legally split the mortgage obligation 50/50. They move into the house and pay you a fair rent in return for living in the half you own.
Then, you use the rent money to offset your share of the expenses, including insurance, repairs, property taxes and mortgage interest. The newlyweds pay any remaining amounts, while you split the cost of any capital improvements.
Finally, the agreement includes a provision that the home is to be sold after five years (or some other time period). The occupants are given the right of first refusal. After five years on their own, they should be able to come up with the money needed to buy you out.
Tally up the tax breaks. The rental income is offset by the available deductions for insurance, repairs, property taxes and mortgage interest, plus depreciation based on 50 percent ownership of the home. You must legally own 50 percent of the home to claim a deduction for that percentage of the interest. You also must charge fair rent for the half of the residence you own.
If you show a loss for a given year, it’s treated as a passive activity loss (PAL). You can use the PAL to offset up to $25,000 of ordinary income. But if your adjusted gross income exceeds $150,000, the PAL carries forward to future years. When you sell your interest in the home, any gain is taxed at favorable capital gain rates.
True, the newlyweds will be shortchanged on their share of the usual tax deductions. But the tax breaks are worth a lot more to you in your high tax bracket than they are to the young couple.
Final tips: Equity sharing usually involves family members, but it can also work with nonrelated parties. Have your attorney handle all the paperwork. And charge a fair rental value to the occupants to lock in your anticipated tax breaks.