Dear Alex:
A good friend and I want to buy a house together to rent out as investment property, but we want to make sure that we are legally set up the right way.
What do we need to do?
There are two primary fields to consider:
1. How will title to the house be held
2. How should you organize your business partnership?
While these areas are separate legal issues, they overlap.
The most common way for investors to take title together is as “tenants in common.”
Tenants in common means that you each own a proportional, interest in the property, but it is an undivided proportion.
For example, if you each own 50 percent of the house, the ownership rights of the property aren’t split in half, where one person owns and controls the north half and one person owns and controls the south half.
Instead, each person owns a one-half interest in the whole thing, and you share ownership and control over the entire property. There are default rules in the law for owning a property as tenants in common which govern what happens when the property requires repairs or improvements, decision-making authority, and other factors which you may not have considered.
You may use a written Tenancy In Common Agreement, to more specifically describe the intended rights and obligations of the co-owners. Upon death of an owner, that person’s ownership interest will pass on to their heirs or devisees according to their estate planning instructions or by operation of law.
A tenancy in common agreement is useful among separate owners who are not necessarily doing business together, but if you intend to continue to purchase properties with this person, another common arrangement is to form a Limited Liability Company (LLC), and for the LLC itself to own and hold title to the property.
The owners each own their agreed upon proportion of the LLC, and therefore own that proportion of the assets held inside the LLC. By structuring your investment this way, the liabilities associated with the property will be contained to the LLC due to the liability protections offered by that business structure.
Your operational rules may be governed by the Operating Agreement of the LLC, much like the Tenancy In Common Agreement would outline the operating rules for tenants in common. It is generally unwise to use a corporation for real estate holdings, because corporations are subject to tax treatments which are different from LLCs and which are not favorable to real estate investment.
In each case, your lender will have specific requirements for you to consider in order to be approved for a loan, and your property insurance provider will need to be informed that the property is intended to be used for investment as a rental.
Both tenancy in common interests and LLC membership interests can be contributed to a trust for estate planning purposes.
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