Dearborn Financing Secrets of a Millionaire Real Estate Investor 2003_6

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Dearborn Financing Secrets of a Millionaire Real Estate Investor 2003_6 95 7 / Partnerships and Equity Sharing together for the purchase of properties at a foreclosure auction. This type of arrangement should be approached with extreme caution because it looks more like a general partnership than a joint venture. It also may cross over into securities regulations, particularly if you are the one soliciting money from other investors.Legal Issues O wning real estate jointly with other parties is an effective financing tool, but it can also be a liability. Under the Uniform Part- nership Act, the law holds all partners liable for each other’s actions. Thus, if you are a “silent” partner, you could be held liable as the “deep pocket.” Consider setting up a limited liability company (LLC) or lim- ited partnership for joint venture projects. The owners of an LLC are shielded from liability for activities of the company and the activities of each other. Limited partners (but not general partners) of a limited partnership are similarly shielded from personal liability. For more information on LLCs and limited partnerships, visit my Web site at .A lternative Arrangement for Partnership Rather than having a partnership own the property, partners can realize the same profit goals by using a note and security instrument. One partner will hold title to the property and sign a note to the other partner for the amount of the other partner’s cash investment. The note is secured by a mortgage on the property. A second note and mortgage is also executed, which will be a shared equity mortgage. A shared equity mortgage has a payoff that is based on a formula that relates to the increase in value of the property. Shared equity mortgages (A K A shared appreciation mortgages or participation mortgages) were popular when interest rates were so high that commercial borrowers could not maintain positive cash96 FINA NCING SECRETS OF A MILLIONAIRE REAL ESTATE IN VESTOR f low. The lender thus dropped the interest rate in return for a share of the future profits in the borrower’s property. Today, shared equity mortgages are not as popular, but they are still an effective tool for financing properties with people who are open-minded. Tax Issue for the Lender Normally, an investor must pay profits when he or she sells investment property for a gain. An owner (or co-owner) of real estate can defer paying taxes on this gain by exchanging under Section 1031 of the Internal Revenue Code. Because the partner holding the shared appreciation mortgage is not an owner of the real estate, he or she is not able to take advantage of a Section 1031 exchange (for more information on tax-deferred exchanging, go to ).Case Study: Shared Equity Mortgage with Seller A viable option for seller financing is to make the seller your part- ner with a shared appreciation mortgage. In this case, the seller/ lender shares in the future appreciation of the property. A seller may be willing to accept little or nothing down in exchange for principal and interest payments, lack of management, and future appreciation. Essentially, the note and mortgage documents read the same as a stan- dard note and mortgage, except that the payoff amount increases over time in proportion to the value of the property. The shared apprecia- tion can be written a number of ways and need not necessarily be a 50/50 split of future appreciation. 97 7 / Partnerships and Equity Sharing Is a Shared Equit y Mortgage a Partnership? W hen using shared equity mortgages, there is a fine line between a lender/borrower and a part- ner/partner relationship. There could be adverse tax and legal consequences if a court or the IRS were to recharacterize a lender/borrower relation- ship to that of a legal partnership. The key legal distinction is the sharing of losses by the lender in the transaction. Because a partnership involves the agreed sharing of profits and losses, removing the lender’s risk of loss will he ...