Question: I currently have a standard mortgage on a single family house which I own by myself. I would like to add my live-in girlfriend to the deed, and she will pay me half of the current value of the house. If I do this, can I retain my current mortgage, thereby avoiding more closing costs and the loss of my current favorable mortgage rate? Also, is this a taxable event which would require me to pay capital gains tax. I know that the simplest solution would be for us to get married, but there are other financial issues involved and we would like to avoid marriage if at all possible at the present time.
Answer: Yes! The best (and simplest) way to accomplish your goals would be for the two of you to get married. However, since you do not currently have marriage on your radar screen, there are a number of options -- and answers to your questions.
You may not realize it, but you have raised a number of issues.
Your Mortgage:
Let us assume that you purchased your home for $200,000, and with the rapid appreciation we have seen in recent years, the house is now worth $300,000. Your mortgage is $175,000. If your girlfriend is going to pay you half of the value of the house, is she going to give you $150,000 in cash, or is she just going to pay you $62,500, which is the difference between half of the current mortgage and half of the market value of the house ( $150,000 - $87,500 = $62,500)?
Do you plan to take all of the tax deductions on your own, or will these be divided equally between the two of you? If your girlfriend wants (or needs) these tax deductions, she will have to be added to the deed of trust (the mortgage) which you currently have with your lender. A taxpayer cannot take deductions for mortgage interest unless the taxpayer is obligated under a secured deed of trust, which means that the document must be recorded among the land records where the property is located.
This, then, goes to your question about your current mortgage. I suspect that it contains a "due on sale" clause, which basically means that if you sell all (or a portion) of your property, your loan cannot automatically be assumed by your buyer. While there are several situations where the due on sale clause cannot legally be asserted (such as where property is transferred in a divorce or death situation), unfortunately, there is no such exemption between boyfriend and girlfriend.
If your friend is not interested in taking the tax deductions, then I suspect that your current lender will not object to having her name added to the title. However, if your friend wants to take these deductions, you will have to modify your current loan documents -- and this may give your lender the option to increase your favorable mortgage interest rate.
Tax Consequences:
You paid $200,000 for the house. Let us assume for this column that you did not make any improvements to the house, and now you plan to sell half of the property to your friend. You will have made a profit of $50,000. If you have not lived and owned the house for at least two years, you will have to pay tax to both the IRS and to your local state government. And unless you have owned the property for at least one full year, you may even have to pay ordinary -- and not capital gains -- tax. You must discuss your particular situation with your financial advisor before you embark on this journey with your girlfriend.
If, on the other hand, you have owned and lived in the property for at least two years, since you are single and file a separate tax return, and if this is your principal residence, you can exclude up to $250,000 of any profit which you have made.
There is another way of resolving your situation, namely, your girlfriend can lend you her "purchase price" and take back a promissory note and secure your obligation with a recorded second deed of trust. Should you decide ultimately to get married, she can forgive and cancel the debt. But, once again, there are taxable consequences involved when a debt is cancelled, and your financial advisor should be consulted on this issue also.
Regardless of how you ultimately structure your transaction, it is strongly recommended that you and your girlfriend enter into a written "partnership agreement," which should be finalized before you transfer any interest in the property to her.
What happens should one of you die? Do you want your girlfriend to inherit the entire property (in which case title should be held as joint tenants with rights of survivorship)? Or do you want your heirs and relatives to get the property (in which case title should be held as tenants in common)?
What happens if one of you decides to end the relationship? What will happen to the house?
Who will pay the mortgage? What if one of you is unable to make the monthly payments?
What about furniture? How owns it? How will it be disposed of should you decide to split up?
These are important questions which must be answered while you are friendly toward each other. It clearly is cheaper to resolve all these important issues now, rather than have to pay two separate lawyers to resolve issues when you are not talking.
Yes, marriage is probably the best solution in the long run.
