Author Topic: Partnerís in rental property with unequal cash equity to contribute.  (Read 2799 times)

K-ice

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So I asked a specific tax question  ďPartners in a rental property, mortgage interest deductionĒ in this forum:
http://forum.mrmoneymustache.com/taxes/can'eh'dian-tax-you-have-questions-i-have-answers/

But I thought I would post the entire scenario here for some feedback.

Basically, if 50:50 partnerís in a rental property do not have equal amounts of cash equity, how would you deal with paying out expenses and paying the mortgage?

My spouse and I own a rental property. We have always shared the expenses and income 50:50, for roughly 10y.
Itís worth about $300,000 and has a $200,000 mortgage on it.

My spouse is in the position to pay out their share of the mortgage with savings, I am not, and would rather Vanguard invest. (The pay-off mortgage vs invest is not something we agree on. Also not something I really need to debate here as I know itís been done.)

The mortgage now goes down to $100K and will probably still be in both of our names (if that matters).
I take over the mortgage payments for the $100K remaining mortgage from my share of the income.  I plan to solely deduct the mortgage interest from my taxes while my spouse deducts nothing.

Rent is about $3000/month.
So with the ďincomeĒ we plan the following:
Keep $1000 in our joint ďrental houseĒ account for taxes and maintenance. (Maybe more than we need but we will adjust annually)
My spouse will take $1000 a month and transfer into their personal account.
I will take $1000 a month and transfer into my personal account.  Out of that $1000 I will need to pay the mortgage which should be about $700. (~$100K at 2.5% for 15years)


What do you think of this plan?  Do you see any issues?  How have you shared a rental property when both partners are not contributing equally?

J Boogie

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Re: Partner’s in rental property with unequal cash equity to contribute.
« Reply #1 on: October 19, 2016, 08:56:59 AM »
Damn man, this makes me quite glad that my wife and share finances. 

Obviously it's not ideal to have this complicated partnership.  I would look for ways you could make an exit.  Since your spouse has a lot of cash, maybe they would be open to buying out your equity stake, which I would imagine is about $50,000.  I know your spouse is looking to pay down the mortgage faster with that money, but maybe they'll prefer being free to make decisions regarding this property on their own.

That's my idea anyways.  Anytime a business partnership meets a fork in the road I'm always in favor of an amicable split that is mutually agreed upon.  It seems like the best way to go as well since you seem to have opposite investing philosophies.

Canadian_Fire_tobe

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #2 on: October 19, 2016, 11:36:37 AM »
Is this not getting overly complicated?

Could you not do the following

1. Pay all expenses (except mortgage) exactly are you are now
2. Sign a document stating you are legally responsible for the mortgage in its entirety (basically remove spouses name) and that the property is owned 50/50
3. Take revenue (however you do it now) split it 50/50, you pay the new mortgage spouse does whatever they like with their funds.

In my mind how you come up with your 50% stake of ownership is irrelevant, whether you paid cash or took our a loan shouldn't matter. Your spouse paying their share of the mortgage early doesn't affect the ownership of the property, all it affects is how much interest your partner pays to the bank.

The real concern is that if the property goes into foreclosure because you didn't pay your share of the mortgage your partner will want a way to protect themselves so they don't lose their equity.

K-ice

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #3 on: October 19, 2016, 01:14:19 PM »
J Boogie, neither of us want out of the property, or the relationship;). I just prefer to invest in Vanguard & have slow & steady mortgage pay-off. They prefer to hoard cash so we might as well put it to work paying down the mortgage. I am just trying to find a fair way to manage different investment strategies.

I imagine this not only happens in couples but business partners or family who may invest in rental properties.

Hundreds of people have debated the "invest or pay down mortgage" strategies on this forum. Now imagine being married to someone who thinks differently than you. At least we are both frugal spenders & good savers.

CF_tobe. Maybe I am over complicating things.

Perhaps to just pay expenses & then take revenue is an easier way to think about it instead of splitting first.

I'm happy to hear other opinions.


zephyr911

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #4 on: October 19, 2016, 02:17:10 PM »
J Boogie, neither of us want out of the property, or the relationship;). I just prefer to invest in Vanguard & have slow & steady mortgage pay-off. They prefer to hoard cash so we might as well put it to work paying down the mortgage. I am just trying to find a fair way to manage different investment strategies.
Yeah, if you just keep splitting the income and the expenses 50-50, and you pay off the rest of the loan in time, you should be good.

DoubleDown

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #5 on: October 24, 2016, 07:52:34 PM »
I'm not sure of the exact question being asked here. Are you asking if the proposed setup is fair? Or how to split equity in the partnership? Or something else?

If you're asking if it's fair, it sounds fair to me. But what really matters is do you both think it's fair? If so, I say go for it.

As far as splitting equity when partners are contributing unequal amounts, I'd say it's pretty simple: Each partner owns a percentage of the equity based on the amount they have contributed, divided by the total contributions made by all partners. Of course, certain partners might get more equity based on work done or other considerations.

When I owned property with partners and we had ongoing mortgage payments and other expenses, I just tracked ALL contributions over time. Every penny that went into the property/business was recorded (as it should be anyhow for tax and other purposes), and credited to the partner who made the contribution. In our case we kept it simple -- I kept a business account with enough money to maintain the property and assessed quarterly, equal contributions to all the partners as needed to maintain enough money in the account or to cover any larger expenses. Partners who made larger up-front contributions towards the down payment had more equity in the partnership, and I got a larger percentage as the managing partner (since I was doing all the work to run the business).

Once proceeds from a sale or any other distributions are made, it's a simple matter of figuring out each person's percentage of the equity and doling out the proceeds based on that percentage.

So say over time that you and your husband put $500,000 in total into the property/business (I picked a round number to make it simple, obviously that won't be the case in real life). All your contributions are recorded in a spreadsheet (as they should be anyhow, see above) for both of you, so it's a simple matter of adding up the totals for each of you. You determine that of the $500,000 total, $304,758 was from your husband and $195,242 was from you.

It doesn't matter what the contributions were for -- whether it was for mortgage payments, insurance, buying cleaning supplies or hiring a maid. All that matters is the bottom line. In this scenario your husband owns 304758/500000th (60.95%) of the equity, and you own 195242/500000th (39.05%) of the equity.

Hope I haven't missed the boat on your question, and good luck!

K-ice

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #6 on: October 25, 2016, 11:38:05 AM »
Thanks. It's not loo late to reply. We still haven't made any major mortgage changes.

I guess the question is more of a fairness question.

I think it is fair, and I know my partner wants to pay off their share of the mortgage and I financially can't.

We are currently splitting the mortgage interest tax deduction 50:50.  If he pays off his share I would like to solely deduct the mortgage interest from my taxes. I think that is fair since I will be the only one paying the remaining mortgage. That is the one financial question I still don't have a clear answer for so I guess I should call an accountant.

braje

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #7 on: October 25, 2016, 01:58:29 PM »

We are currently splitting the mortgage interest tax deduction 50:50.  If he pays off his share I would like to solely deduct the mortgage interest from my taxes. I think that is fair since I will be the only one paying the remaining mortgage. That is the one financial question I still don't have a clear answer for so I guess I should call an accountant.

Are you also filing MFS?

K-ice

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #8 on: October 25, 2016, 04:33:12 PM »

We are currently splitting the mortgage interest tax deduction 50:50.  If he pays off his share I would like to solely deduct the mortgage interest from my taxes. I think that is fair since I will be the only one paying the remaining mortgage. That is the one financial question I still don't have a clear answer for so I guess I should call an accountant.

Are you also filing MFS?

No, MFS doesn't apply to us in Canada. We can only write off mortgage interest on a rental property or part of our home if you operate a small business from home.

Kind of sad really, but I think it helps motivate Canadians to pay their primary residence mortgages faster as there is no tax incentive to drag it out.


DoubleDown

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #9 on: October 26, 2016, 02:14:19 PM »
I think it's fair to solely claim a deduction on interest that you are solely paying, but on a practical level I don't know how you'd separate that if you file taxes jointly. How would you know what eventual impact that deduction would have on your "bottom line" tax assessment? But if it works for you guys (i.e., you're both happy with it and can figure it out) I say go for it.

Goldielocks

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #10 on: October 27, 2016, 02:47:13 AM »
If this were a partnership. And you current agreement only covered 50:50, then you would dissolve the agreement and write out a new one with the terms you specified.

As you are married, make a note of it, date and sign it with the amounts and intent, and you are set in case of any questions.

Just do this because you have different investment goals, not to restructure just to avoid taxes. CRA doesn't like it when you do that.

Cathy

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #11 on: October 27, 2016, 11:03:03 AM »
If this were a partnership. And you current agreement only covered 50:50, then you would dissolve the agreement and write out a new one with the terms you specified.

As you are married, make a note of it, date and sign it with the amounts and intent, and you are set in case of any questions.

I'm not sure what goldielocks intended by this post, but generally speaking, married couples may want to consider a high level of documentation of their business arrangements. One reason for this is that the parties to a marriage may be in a confidential or fiduciary relationship at law. See generally, e.g., Vaseloff v. Leo, 2014 ONSC 5227 at ∂∂ 17-36. In Canada, the law does not appear to be very well developed on the topic of what fiduciary obligations, if any, flow from a confidential married relationship, but generally speaking in mutual confidential relationships the parties may be held to higher standards of full disclosure and fair dealing with each other, see, e.g., Halcrow v. Canada (Attorney General), 2003 FCT 782 at ∂ 75, which can be relevant to the analysis of agreements entered into by those parties with each other during the relationship. Formal written agreements and other documentation, as well as independent legal advice, can be useful to demonstrate that all possible confidential obligations were complied with.

For those reasons, I recommend that the original poster and his or her partner each retain independent counsel to negotiate and conclude a formal written agreement reflecting their understandings.


Note: I make no comment on any tax issue or on any other issue that this post does not specifically comment on.
« Last Edit: October 27, 2016, 12:12:49 PM by Cathy »

Goldielocks

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Re: Partnerís in rental property with unequal cash equity to contribute.
« Reply #12 on: October 27, 2016, 04:21:13 PM »
Hi Cathy,   thanks for the info...

The reason I said that married couples can just make a personal documentation of it, and sign it and file it (without notarizing or legal) is because married people generally don't consult independent counsel EVER unless there are significant assets involved or complexities of mixed / combined families and second marriages.

Actually married couples often do NOTHING, which becomes a problem when you are not splitting 50:50 everything, (contributions and income  and gains), and when the CRA starts to ask questions.   With a long term investment like real estate, if is very possible to trigger a minor audit sometime in the next 15 years on an unrelated issue, and also have the real estate income question come to light.   So, a document of some sort beats nothing, any day.    As you indicate, it may not be enough for all situations.


For those reasons, I recommend that the original poster and his or her partner each retain independent counsel to negotiate and conclude a formal written agreement reflecting their understandings.