Lake house purchase...parents want in

[Larry Mankins]

Wife and I are looking at retirement/recreational property we won't occupy full-time for 10+ years. Will be happy to vacation there several times a year, we love the lake. Parents want to throw money in so they can use several weeks a year, which we are ok with. We will pay mortgage/upkeep and ultimately occupy so not sure we want everyone on the deed. Place is zoned to rent nightly and rents for several weeks/year conservatively. Is there an arrangement that would accomplish our objectives and provide them some return/tax advantages now? Our plan is to issue p-notes to them to repay upon sale the % they invested and share any rental income after taxes/costs. We are preapproved way above house price, all have scores >780. Ideas?

[Jon Holdman]

This has "bad idea" written all over it.

First you say this is recreational/retirement property. Then you talk about sharing rental income. You mention it will rent for several weeks a year. Without knowing any numbers, I'd hazard a guess there will be no net rental income. You may collect a little rent, and it may offset a bit of the mortgage payments and expenses, but there's not going to be any profit.

Its tough to truly make a profit on any rental property. "Nice properties", and this one sounds nice (my wife would love a lake house), typically make really bad rentals because the price to rent ratio is out of whack. Vacation rentals do have higher rents than long term, but they also have higher expenses since the agents that do this charge much higher rates and you have to keep it furnished. Maybe you will manage it yourself (if allowed, some localities requires special licenses for this sort of rental), but it will take work on your part.

If you use a rental property more than 14 nights a year (IIRC) you lose the "rental property" treatment. More specifically, you lose the depreciation deduction, which is typically the source of the "tax advantage". That advantage is much more limited than you will be told by people who have a vested interest in buying property, so be sure to have a chat with your CPA about this topic before you jump in.

It sound like you like this place and can afford it, and that any rent coming in would just be gravy. Great, move ahead. Just don't expect there are any real tax advantages or that there will be any net income.

So, how do you fit the folks into the picture. I wouldn't try to make them a partner in this deal. Partnerships are messy at the best of times. Partnerships with family can result in strained Christmas dinners. I assume you don't want that. This is a complex partnership because both of you want to use the property, but only you will be on the deed and paying the mortgage.

It doesn't sound like you need their contribution to buy this place. If not, why not just be the good children I'm sure you are and just let them use it for free? My wife and I own a house next to my mother-in-law's house, and we let any of the family who wants use it for free. Well, we have them contribute to the utilities, sometimes. But it costs us nothing and maybe encourages them to visit mom a little more.

If that doesn't fly, how about having them loan you some money, then offsetting the payments with the use of the property. For example, say they loan you $50K that you use toward the property, and you agree on an interest rate of 8% (that's their return on this deal.) Say the place normally rents for $300 a night, but you make the rate for them $150. Daily interest on the loan is $10.95. Every six months they go and stay two weeks. After six months, the accumulated interest would be $2000. 14 nights in the place would have a value of $2100 (14*$150). Their use of the property covers the $2000 interest plus $100 toward principle. That keeps the deal much cleaner than trying to set up a partnership.