Silent Investor Problems

[Richard York]

Hi all,

I've got a bit of an issue and would like to see if anyone has any advice for me. I made the mistake of investing with a family member and this person now wants to pull out of the deal after 3 years. We had agreed that this was an option all along so we have to find a way to make it work now. Basically, we purchased a SFH 3 years ago and this person contributed cash for a 20% share of the property. Everything has been done informally and the home is in my name and she's done nothing other than send the cash. So basically, she put $21k cash in, I put the rest to get to the min down and then I mortgaged the rest. These are my calculations (rough estimate) on how to buy her out:

Partners's initial investment: $21,400 cash

20% of appreciation based on $175,000 estimated value of home today: $175,000-$107,000 (purchase + expenses) = $68,000*20% = investor's share $13,500

So partner's current equity in the property is $34900

In order to take cash out of the property/refinance, there are expenses:

$2400 legal, appraisal and other bank fees

$ 4000 penalty to take cash out and refinance

25% capitals gains will also be charged to us when we eventually sell the property. If we were to sell today we would pay 25% of the $68,000 appreciation above. This is an additional tax of approx. $3400 on her share of appreciation.

Total expenses to pull cash out of the house is: $9800

Total appreciation minus expenses is $3800 

Total that we would pay to investor is: $21400+ $3800

HOWEVER, the mortgage penalty is not strictly her fault as she didn't have any part of the mortgage.  I'm not sure if any of these expenses should be allocated to her.  Basically, if she had not chosen to take her cash out, we wouldn't be having to pay this.

Anyone know how a more formal agreement would have been structured?

Thanks in advance!