Shared Ownership Top 10 Issues
The Stress-Free Way To Buy and Owner Property With Friends and Family
Top Shared Ownership Issue #1: Title And Ownership Structure
The “title” or form of ownership of real estate impacts numerous shared ownership issues, including:
- Regulation: How the co-ownership will be regulated, and what requirements apply to creation of the shared ownership and the sale or resale of shared ownership interests
- Gains Taxation: How the co-owners will be taxed on money they make from operating the property (if any) as well as profits they make when it is sold
- Tax Deductions: Whether the co-owners will be able to deduct expenses such as mortgage interest, property tax, and depreciation, and whether deductions can be offset against income not derived from the property such as wages
- Liability: Whether the co-owners are protected against claims that can be made against them in connection with the property, such as when someone is injured on the property or when those providing services for the property are not paid
- Protection Form Creditors of a Co-Owner: Whether the property and/or a co-owner are protected from another co-owner’s creditors
- Disputes and Defaults: How shared ownership disputes are resolved and the consequences when a co-owner does not fulfill his/her obligations
- Death: How the death of a co-owner will affect the other co-owner(s), and what will happen to the deceased co-owner’s share
When you buy real estate, either alone or with another person, you need to decide how title will be held, and your decision will determine what is written on the deed to the property. Title to real estate can be held either directly, meaning the co-owners names show on the land registry or deed, or indirectly, meaning a company, trust or other entity is shown on title and the co-owners share ownership of the entity.
But while the manner of holding title is important, it is not always the final determinant of how the property is owned. An owner’s behavior (and that of his/her co-owner) can sometimes override what the deed says, and that is one of the many reasons a written agreement is critical.
Top Shared Ownership Issue #2: Usage Rights
Although the right to occupy shared property is generally the most valuable right associated with ownership, many co-owners completely fail to address the issue when planning their shared ownership. This omission is particularly common among groups of friends or family, who typically assume they will be able to work out how the property is used later. The result of this pattern is that usage issues are by far the most common subjects of shared ownership disputes, particularly among groups of friends or relatives.
Make firm usage rules even if your intention is to try to handle usage arrangements informally. The rules will give the co-owners something to fall back on if the informal approach fails at some point. Avoid arrangements that require one co-owner to contact the other(s) prior to usage, as this prevents advance planning and becomes inconvenient. Also avoid assuming that all the co-owners will always want to be at the property together, since the freedom to invite guests is a significant element of ownership.
To avoid unfairness, the allocation of usage rights must be related to the economics of ownership. If a co-owner has made or is making greater economic contributions to shared ownership, he/she should have greater usage rights. Conversely, an owner who has greater usage rights should have made, or be making, greater economic contributions. While ignoring this general principal may seem palatable at first, the co-owner getting less than he/she is paying for, or his/her successor in interest, will eventually resent being taken advantage of, and likely try to extract his/her “ounce of flesh” eventually, either directly or indirectly.
Top Shared Ownership Issue #3: Contributions Of Funds To Purchase
How much each co-owner contributes to the purchase of the shared property must be considered in determining how the various future rights and benefits of ownership will be allocated among the co-owners. These future rights and benefits include usage rights, tax benefits, income allocation, decision-making power, and future appreciation. When analyzing contributions to the purchase price, look beyond the cash deposits, and consider additional factors such as obligation to service and repay a mortgage loan, qualification strength on a loan application, finding the property, putting the co-owner group together, and so on.
There are many ways to treat disparities in the co-owners’ contributions to the purchase of shared property, such as:
- Basing the allocation of usage or income rights on the contribution;
- Considering the excess contribution of one co-owner to be a loan to another, to be repaid at some future time; or
- Giving one owner a greater share of the potential future appreciation of the shared property.
Top Shared Ownership Issue #4: Contribution Of Services
Many shared ownership arrangements involve a promise by a co-owner to provide a future service to the other co-owner(s), such as construction or management, in exchange for a reduced contribution to purchase price, reduced payment obligations, or increased usage rights. These arrangements often become problematic because (i) the services are not performed well, (ii) the services are not performed cost-effectively (resulting in additional material costs or waste), (iii) the services are not performed on time, or (iv) the co-owner promising to provide the services becomes unwilling or unable to do so.
The best advice about future contribution of services by co-owners is to treat the service relationship as if it was arms-length. The service obligation should be completely described in a written agreement, including scope of work, time period for performance, how and when compensation is payable, and what will happen if one or more co-owners are dissatisfied with the arrangement. Avoid any arrangement where the scope of work will be decided on a day-to-day basis, or where compensation is based on time spent, as these types of arrangements often lead to disputes.
Top Shared Ownership Issue #5: Income And Expense Allocation
Income and expense allocation among co-owners must be fair in light of the benefits each co-owner is receiving from the shared property in both the short and the long run. When considering how to allocate income and expenses, it is critical to focus on past contributions of funds, the obligation to contribute funds in the future, the allocation of usage rights, the allocation of future profits from resale, and the risk of loss from property depreciation or damage.
It is not necessary that all expenses be allocated among the co-owners equally; in fact, equal allocation has absolutely no benefit over unequal allocation. Nor do ownership percentages need to determine how each expense is allocated. Ownership-based allocation may be appropriate for all of the expenses, some of the expenses, or none of the expenses, depending on the fairness factors mentioned above.
Similarly, there is no benefit to allocating each expense in the same way. For example, in a group mortgage situation, the allocation of mortgage interest should be based on how much of each co-owner’s purchase price he/she has borrowed rather than on how much of the property he/she owns, and this means that mortgage interest is likely to be allocated differently than, say, insurance.
Also keep in mind that expense allocation need not determine current payment obligations. It is possible to charge an expense to one co-owner, but have another co-owner pay it because the first does not have adequate means at the time payment is required. In this situation, the owner paying the expense is deemed to have made a loan or advance to the other co-owner, creating a future obligation for repayment, with or without interest, or perhaps as an additional share of property appreciation. This type of arrangement allows co-owners to have a fair allocation of expenses even when one co-owner cannot fully support his/her share.
Top Shared Ownership Issue #6: Accounting, Bill Payment And Management
No matter how friendly you might be with your co-owners, and how informal you would prefer to handle your shared ownership affairs, it is essential to have a more formal backup plan in case things don’t turn out as planned.
Having owners contribute money “as needed” presents significant problems in communication, expectations and enforcement. Will it always be easy to tell each co-owner what is needed? How will you ensure the message gets through on time? What if a co-owner is not prepared to make the required contribution? If a co-owner does not pay, how can you establish that his/her obligation has not been fulfilled when so many arguments can be made about the process?
The answer to all these problems is an annual budget, made in advance, including all the anticipated expenses and income (if any), coupled with a pre-set schedule of regular contributions. Although this system is based on estimates that may turn out to be inaccurate, it will generally tell each co-owner what payments are due when, and provide a clear determinant of when a payment obligation has not been fulfilled.
The budget and payments should include a reserve component so that funds are reliably available to pay for major repair and replacement. Any reserve is better than none, but basing the reserve amount on a wild guess is only slightly better than having no reserve. The wise approach is to make a list of the items and elements with a useful life of 15 years or less, calculate the cost of replacement or refurbishment, then spread that cost equally over the useful life.
Even where all the owners plan to share in the duties of managing the shared property, someone needs to bear ultimate responsibility for each task at any particular time. Where no one is ultimately responsible, or where responsibility is shared (which is really the same thing as having no one responsible), there is great risk that an important task will go undone. Make a list of the management duties (both financial and physical) and assign responsibility for each duty to either a co-owner or an outside manager. Don’t assume that the same co-owner, or his/her successor in interest, will have the ability or the desire to perform the same management duties forever, will always want to do more work than the other co-owners without being paid, or will always do a good job.
Top Shared Ownership Issue #7: Making Decisions And Resolving Disputes
Making decisions in a shared ownership arrangement is only problematic when co-owners disagree, and it is important to assume future disagreement when creating rules and procedures for decision-making. The most common shared ownership mistake, by far, is assuming that the co-owners will always be able to work things out. Two (or more) completely reasonable and friendly people can reach different conclusions as to the best course of action, and believe so vehemently in their respective viewpoints that they are unwilling to compromise.
Common wisdom is that shared ownership in general, and making shared ownership decisions in particular, is easier when there are only two co-owners. This assumption is completely wrong; in fact, the highest incidence of shared ownership disputes occurs in groups of two co-owners, two couples, or two families. The problem with shared ownership groups of two is that there is no obvious way to resolve a disagreement.
The best way to deal with decision-making and dispute resolution in groups of two is for the shared ownership agreement to pre-resolve as many potential disagreements as possible. For example, the agreement might say that no alteration of the property will occur unless both co-owners agree. Under this provision, if one co-owner wants to make a change and the other does not, the result is crystal clear—the alternation is not made. Similarly, the agreement might say the property will be re-painted as soon as it starts to peel unless both co-owners agree to wait.
This pre-resolution approach will not work for all issues, and the sharing owners will need to fall back on some form of dispute resolution in these instances (such as which contractor’s bid to choose for the repainting). Because most court systems are slow and expensive, you should require those disputes not resolved by the shared ownership agreement to be submitted to mediation or, if that does not work, binding arbitration. Keep in mind that time is your greatest enemy in shared ownership disputes, because the continued existence of the dispute is likely to take a significant toll on both the property and the co-owners.
In shared ownership groups of three or more people, couples or family groups, decisions can be made by vote. In shared ownership voting, the key issue is protecting the rights of the co-owners in the minority. To illustrate this point, imagine a shared ownership arrangement where three families agree to share a second home equally. If their shared ownership agreement provided that “majority rules” on all decisions, two of the families could theoretically vote to prevent the third family from ever using the property. Perhaps such a decision would be justified or fair under certain circumstances, but what co-owner would want to leave such an important and fundamental ownership right entirely in the hands of others?
Protecting the shared ownership rights of all the co-owners requires some form of “tiered voting”, under which some decisions require a vote of all the co-owners. In larger shared ownership groups, there might be several tiers of decisions, some requiring a simple majority, others requiring a larger majority, and still others requiring unanimity. Depending on the size of the co-owner group, it may be advisable to delegate certain decisions to a subgroup of co-owners, such as an elected board or committee. In each case, you must balance the competing needs to (i) make decisions quickly and efficiently, (ii) avoid decision-making paralysis (where one recalcitrant co-owner effectively blocks day-to-day operations, and (iii) protect each co-owner’s fundamental ownership rights.
Top Shared Ownership Issue #8: Exit Strategy
It is naïve to assume that all the co-owners will want to continue their shared ownership forever, or that all will want to end the shared ownership at the same time, even if they are close friends or family, and even if they all express perfectly harmonious intentions at the outset. The reality is that co-owners die, become ill, and age, their physical and economic circumstances evolve, and the shared property itself may change in ways that affect each co-owner differently.
Moreover, all co-owners suffer when any co-owner is forced to remain in the group against his/her will. A reluctant co-owner is never a good partner, and his/her resistance to contributing enthusiastically to the co-ownership, and desire to create conditions that will lead to an exit opportunity, will inevitably interfere with the enjoyment and benefits of shared ownership for the others.
These principals were acknowledged in ancient common law through creation of the “right of partition”, under which any co-owner can force a physical division of the shared property, or its sale (if a fair physical division is impossible or prohibited by law) at any time. Although the right of partition still exists in many places, it is a mistake to rely on it because: (i) it applies only to direct ownership structures (i.e. where the co-owners are named on title); (ii) it is an expensive legal process; and (iii) it generally does not create an optimal or fair economic result.
The wise approach to exit strategy is to make sure the key exit questions are answered at the outset of the shared ownership, and that the answers are expressed in a written agreement. Those questions are:
- Can a co-owner sell his/her shared ownership interest? When and how can it be sold? Is such a sale subject any conditions, such as a preemptive purchase right by the other co-owners, or approval of the buyer by the remaining co-owners? Do the same sale requirements apply to a sale to a friend of family member?
- Under what circumstances will the entire shared property be sold? How many co-owners must agree to a sale? Do the approval requirements change over time, so that, for example, the number of owners who must support a sale diminishes? Is there a point in time when the shared property will be sold unless all the co-owners want to keep it?
- In a situation where the entire shared property will be sold, what procedure will be followed? If one owner is more anxious to sell than another (a situation which is almost inevitable), how will pricing and price reductions be determined? Will one owner have the right to stop the sale of the shared property by buying out the other(s)?
- In light of the agreed-upon exit strategy as expressed in the shared ownership agreement, should the right of partition be limited or waived? If the partition right is not waived, will it undercut the agreed exist strategy by giving a disgruntled co-owner a “lever” to use against the other owner(s)?
Top Shared Ownership Issue #9: Death Of A Co-Owner
The death of a co-owner inevitably affects the other co-owners, and considering the potential fallout of a co-owner’s death is essential to avoid unpleasant problems. In general, it is legally impossible for the co-owners to control who inherits the deceased owner’s share, and if you are advised otherwise you should get a second opinion. More important, controlling how a co-owner’s share passes is highly intrusive, even in a close-knit family situation, and resentment is a common result.
The best approach to the co-owner death issue is to assume the shared owner group has no control over who inherits, and focus on the aftermath of the inheritance. Consider the following questions:
- Following a death, should the surviving co-owner(s) have the right to buy out the inheritor(s) and, if so, on what terms and for how long? Should the rules for buyout be different depending on who inherits?
- Should the rights of an inheriting owner be different than the rights of the other co-owner(s)? For example, if the deceased co-owner had the right to force a sale at the time he/she died, should someone who inherits a share be able to force a sale immediately?
Top Shared Ownership Issue #10: Written Co-Owner Agreement
People and circumstances change in unforeseeable ways, and new people can come into a shared ownership group at any time as a result of death or other unexpected events. When these changes occur, even the best of friends, the closest of families, and the most agreeable and easygoing people in the world, can disagree. The purpose of a shared ownership agreement is to help resolve these conflicts quickly, inexpensively, and without ruining the personal relationships of the group members.
The only part of a shared property agreement that matters is the “key clause”, the provision that applies directly to the circumstances that force you to consult the agreement. Unfortunately, you never know what the “key clause” will be when you prepare the co-ownership agreement. If the “key clause” is missing because you tried to keep the document short and simple, the shared ownership agreement will be useless. As long as a shared property agreement is clear, it can never be too long…only too short.
Even a well-prepared shared ownership agreement should be used only when friendly relations among co-owners break down. While it is useful to have co-owners’ rights and duties well defined, relying on the co-ownership agreement to dictate a response to actual events is unwise. Even the best agreement will rarely anticipate all circumstances, and applying a formulaic response that does not quite fit the situation may not reveal the best course of action. Such an approach encourages co-owners to adopt firm positions based on agreement interpretations, and an impasse may develop. A better strategy is to rely first on discussion. The goal should be to develop a consensus that all owners can accept even though some may believe that the agreement dictates a more personally advantageous decision. If a consensus cannot be reached, the co-ownership agreement should provide a final resolution.
About the Author
D. Andrew Sirkin is a recognized expert in fractional ownership and other co-ownership arrangements including shared vacation homes, TICs, equity sharing, co-housing, and legal subdivisions such as condominiums. His practice areas include transaction planning, offering materials, co-ownership agreements and CC&Rs, entity formations, regulatory approvals, fractional lending and mediation. From offices in San Francisco California, Evergreen Colorado, and Paris France, he has worked on projects all over the World, including most U.S. States, as well as Italy, France, Spain, Portugal, Ireland, Argentina, Nicaragua, Costa Rica, Panama, Dominican Republic, Nicaragua, Belize and Mexico. Since 1985, he has prepared fractional ownership documentation for over 6,000 clients. He is an accredited instructor with the California Department of Real Estate, and frequently conducts co-ownership workshops for attorneys, real estate agents, corporations, and prospective home buyers. Andy is the co-author of The Condominium Bluebook, published annually by Piedmont Press, and The Equity Sharing Manual, first published by John Wiley and Sons in November 1994 (order the book). He has written numerous articles on related topics, including “Fractional Ownership” and “Questions and Answers on Tenancy In Common”, all of which are available at www.andysirkin.com. Mr. Sirkin can be contacted via the contact form.