Real Estate Co-Ownership Explained
When multiple people own real property together, they own it either as joint tenants or tenants in common. Joint ownership may arise from a deed, will, trust, or operation of law. Regardless of how the parties’ ownership is created, it has the same effect. Ownership as joint tenants or tenants in common is the only way for property to be owned by more than one person in California. The term joint tenant is often confused or used interchangeably with the term tenant in common. It’s important to know the distinction between these two types of ownership so that you can properly apply the rules applicable to these kinds of ownership in a buyout agreement.
The most important distinction between joint tenants and tenants in common is that on the death of one of the joint tenants, the deceased joint tenant’s interest in the property passes to the surviving joint tenant by operation of law. On the death of one of the tenants in common, the deceased tenant’s interest in the property goes to the deceased tenant’s heirs and/or beneficiaries under his or her will. This is the most important thing to remember about jointly owned property , since it is not unusual for the owners of California real estate to die without having prepared a will, which usually sets in motion a process of inheritance lengthy enough to ensure that the property you inherited falls into disrepair.
Real estate may also be owned by cohabitants in common as community property, or as community property with the right of survivorship. Community property is property acquired during marriage, whereas property owned prior to marriage or received by way of gift or inheritance is separate property. Courts presume all property is community property unless one spouse can show otherwise.
Both joint tenancy and community property may be owned in equal or unequal proportions. If co-owners cannot agree about how the property may be used, a court will first need to determine whether the co-owners own the property as joint tenants or tenants in common. This analysis is relevant to whether or not a buyout agreement can mandate how the property will be used and managed after the buyout is initiated.
The Buyout Agreement Defined
The purpose of a buyout agreement is to handle the transfer of ownership between co-owners of real estate, essentially splitting the "title" into two or more parts. Perhaps one owner wants to sell to the other, or perhaps a third party is interested in purchasing it from one or more owners. Either way, there are vital considerations to make and concrete steps to take, which a buyout agreement facilitates. Instead of treating the co-ownership as still intact, a buyout agreement will, for one, outline the terms of the mundane but necessary steps required for the sale, such as compensating the remaining co-owner for their interest or relinquishing the interest entirely as is relevant. It will also include the agreed-upon value of the property so that the transaction can be considered fair. If the price is based on comparative market studies, it is important to remember that the value will not equal the owner’s current equity in the property, as any outstanding mortgages will need to be paid off, as well. An appropriate price should account for this and other expenses associated with the process, including how closing costs will be handled. When it comes to real estate, there are multiple ways to divide things up, and those selected must be fair, enshrined in the buyout agreement, and mutually agreed upon before the current owners proceed with their plans.
Determining Value of Property for Buyout Purposes
The method chosen to determine the value of the property will impact many key components of the buyout agreement.
Step 2: Determining the Property’s Value There are different ways to determine the value of a piece of real estate. It is generally a good idea to get an appraisal of the property and have it appraised by an appraiser who specializes in valuing real estate. Otherwise, a reasonable alternative is to hire a real estate broker to do a Comparable Market Analysis, or C.M.A. See, for example, http://www.thecma.com. If the parties are able to agree upon what the property is worth, and agree on a Buyout Agreement amongst themselves, they need not have the Court make that determination but the Court must approve the Agreement as to form. This agreement does not change title to the property from Joint Tenancy to Tenancy-In-Common. If the parties cannot agree on the valuation of the property, the Court, or a retired Judge of the Court, can order that an appraisal be made, and it will then determine all payment terms and conditions, including the method of payment such as by installment, or in one lump sum. The determination of the value of the property will also presumably impact alimony, child support, health insurance, and tax treatment of payments and transfers. Again, the method chosen to determine the value of the property will impact many key components of the buyout agreement.
Paperwork and Legal Elements
The next thing to consider is protecting the buyer’s ownership interest, and you will want to establish a timeline for the transfer of the interest, including providing the necessary documentation to show the buyer’s interest in the property. There may be a document or two that you will have to prepare for the buyout attorney to draft for you.
Although most people think that attorneys charge a lot of money and do not really do anything that you can’t do, the legalities involved with real property interests are a lot more complicated than you may think. You need to seek help from a real estate attorney if you are planning to do a buyout. You want to ensure that all interests are properly protected, that the agreement is binding, and that the assets you are relinquishing are released properly.
The attorney will prepare a quit claim deed that will be signed by the person retaining an interest in the property and transferred to the other party. Under this situation, the party retaining an interest in the property is saying, "I give up my interest in this property." It basically transfers the interest in the property from one person to the other without any guarantees or warranties regarding the property.
Especially in California, which has some of the highest closing costs in the nation, the attorney should be able to get that fee down for you. This will save you a lot of trouble in the long run, especially if you have a real estate sale that will based on the buyout.
Negotiating a Buyout Agreement
Negotiating and reaching an agreement over the buyout can be relatively straightforward or quite complex. Often, two co-owners who simply saw a piece of property and thought it would make a good investment decide later that their joint investment is not so great, and they wish to go their separate ways. But other times, decades-long co-owners are caught up in a marital separation or divorce where, although they have not divorced, everything is "up for grabs," so terms must be negotiated.
No matter what the impetus, both parties should be open and fair in negotiation. The best way to end up with a successful negotiation is to preserve the kind of relationship and respect that allows two former owners of a piece of property to get along with the new owner who buys the other’s interest. The best way to do that is to reach a fair number that represents the true value of the interest being purchased.
This means, whether the negotiations and ultimate buyout agreement is between two co-owners or a co-owner and an outsider, having a true, independent outside appraisal performed so that there is no question over how the ultimate price was determined is crucial.
Most, if not all , states have laws dealing with "partition" actions between co-owners. A "partition" is the legal process by which a co-owner will go to court to force the sale of the property and/or to force the property to be divided into portions for each party to own. While partition is a necessary tool at times, it is often a forced situation. The parties get lawyers involved to protect their interests. The lawyers charge considerable fees. And the net result of the forced partition is that both parties lose a chunk of their money to the lawyers.
When two parties are negotiating voluntarily between themselves, they can use the cost of a partition as leverage in the negotiation. If one party is insisting on a higher price than the value of the interest, negotiation will collapse and then the other party will have to go file the partition. No one wins. So, before litigation, everyone should treat the other party fairly and openly.
If real estate is being conveyed to one of the co-owners as part of a divorce because the parties want the property to remain in one party’s family, those parties will be able to negotiate a fair deal, but it might not be a fair deal between a divorcing couple.
Completing the Actual Buyout Agreement
Once you’ve reviewed and negotiated your buyout agreement to your satisfaction, it’s time to sign and execute the deal. This process could be relatively straightforward, or it may require a little more effort depending on the particular circumstances of the property. For example, if there is a mortgage in place, you will want to ensure that the lender has been made aware of the sale and is willing to release the seller from any obligations it may have on the mortgage. In situations where there is no mortgage, or if your mortgage lender has granted you permission to proceed with the sale, you may be able to finalize the agreement and move forward with the buyout quickly.
In Northern Canada, many buyers and sellers of property are moving forward with agreements that involve payment for the property through a simple contract. However, there are still some circumstances whereby the buyout agreement itself might involve payment in the form of a formal mortgage-put agreement whereby the buyer pays the homeowner through the issuance of a mortgage on the property post-agreement. These mortgage-put agreements can involve multiple steps involving other professionals, but in each case the rights and responsibilities of both parties need to be clearly defined.
If it’s a simple agreement, both parties will typically sign a written agreement detailing the property in question and all pertinent terms of the agreement. Upon signing the agreement, the new homeowner has a legal agreement outlining the terms of their agreement and can refer back to it if any questions should arise in the future. A buyer who has paid cash for a property may want to secure the sale by retaining the original copy of the signed agreement, while the seller should be sure to retain a copy of the agreement as well.
If your agreement involves a mortgage, whether it is a mortgage-put agreement or a standard bank mortgage, once the agreement has been prepared and signed by all parties, the seller will usually require the services of a notary public or escrow agent in order to finalize the agreement and transfer ownership of the property. The notary or agent will hold the money in trust until all conditions of the sale have been met by both parties, at which point they will hand over the keys to the new homeowner, collect the keys from the seller, and finalize the transaction transfer.
In addition to a mortgage, or if you do not have an agent or are worried about giving your money to someone you don’t trust, you may want to consider working with an escrow company to retain your money until specific conditions of the sale have been met. An escrow company is a third-party hold on the funds involved in the sale, meaning that the seller will not receive any money from the sale until their conditions of the sale have been met and the terms outlined in the agreement have been fulfilled.
It may seem somewhat like a nuisance, however using an escrow company protects both the buyer and the seller, simplifying the transaction and instilling piece of mind as one or both parties is assured that the other will fulfil the agreement now that money will not change hands until they’re ready. Once the agreement is fulfilled and both parties have completed all requirements of the sale, the escrow company will facilitate the purchase or sale of the property, hold the buyer’s money in a secure account, and prepare the deed for transfer to the new owner.
Buyout Agreement Tax Consequences
One significant consideration when crafting a buyout agreement for jointly owned real estate involves how the transaction will be taxed. When one co-owner buys out the other(s), it is essentially all-cash in that the amount paid to the exiting owner will be used by that individual to purchase replacement property. Usually, this means the sale does not trigger capital-gains taxes, as the exiting co-owner is reinvesting the income derived from the real estate into the purchase of new property. In addition, there is no adjustment to the property tax assessment while the existing owners continue to own the property.
However, the situation is a bit different when the buyout agreement calls for a payment plan over a set number of years or the purchase price is deferred in any way. Because the property is owned personally, capital gains taxes may apply upon its sale if the property has gained in value. While jointly owned real estate such as a family cabin often appreciates in value, commercial real estate as an investment may not do so. If capital gains taxes are likely , the remaining real-estate partners may wish to arrange the buyout in a single lump sum, with no subsequent payments owed. Otherwise, capital gains taxes of up to 20 percent of the gain in value of the property may be due to each owner at the time the buyout occurs. Tax credits have already been given for the purchase of the new property, which may affect the amount of capital gains that could be applied. In addition, depreciation credits may reduce the cost basis of the property involved, resulting in additional capital gains paid.
Another important consideration is the issue of property taxes. In some states, the property tax may be reassessed based on the value of the property at the time of the buyout, while in others, the reassessment will occur only if the buyout changes the nature of the ownership to a poorly rated class of ownership in terms of tax benefits. This is not an issue with commercial real estate for which the owners provide manning plus maintenance expenses, but it may open a tax equivalent for non-business owners from a tax standpoint.