Q: My friend and I are buying a house together – he as an investment and me as my residence. The downpayment money will come from him and I will build up my equity through fix-up work around the house and by getting a credit for part of the monthly "rent" payment. We plan to rent a portion of the house out. How should we structure the arrangement?

A: This issue seems to come up often in one way or another – investment/ residence partnerships such as yours, parent/college child arrangements, sale by owner where the owner wants to continue to share in appreciation and delay paying capital gains, etc.

First, usually all parties want to be on the title. In that case the real estate should be held in tenants in common, not joint tenancy with right of survivorship (unless the intent is to have the survivor obtain the entire parcel if either party should die). That way each can dispose of his or her half of the property by Will.

Next, to make up for the difference in the equity contribution, the one who did not contribute half of the equity should sign a demand promissory note payable to the other for the difference between half of the property's equity less what was contributed. The promissory note itself should have room to list payments (or in your case also the credits for work done) so it is clear on the face of the note what the balance is. The note may or may not be secured by the real estate (some first mortgages prohibit back-up liens and consider this grounds for accelerating the loan and calling for the entire loan balance to be immediately due and payable). The note can have any interest rate, but if the rate is below the IRS's imputed rate, the holder of the note must report the imputed interest amount on his or her income tax return even though the amount was never received.

If the person signing the note dies, then the other can be assured of payment for the remaining balance evidenced by the promissory note. If a promissory note is not signed, then a taxable gift has been made for the amount of half of the equity that exceeds $10,000. And for both tax and legal considerations, without a note it probably will be difficult to prove that a loan was made as opposed to a gift and what is the current balance owing.

In your case, the investor gets to deduct and depreciate his or her share of the house but must report the appropriate "rent" on his or her tax return. The resident/owner qualifies for the $250,000 capital gain exemption after two years and the normal "owner" tax benefits.

The non-resident "owner" could simply take a promissory note (basically just loan you the money) and not go on title with you but many investors want to share in the appreciation to sweeten the overall rate of return and generate extra tax deductions. Additionally, without the investor, financing may be difficult to secure if the "equity" is borrowed, not to mention even qualifying for the loan.

Finally, this arrangement could be structured as an installment sale with an escrow agent holding executed deeds and other documents, but the expense and complications, at least in Colorado, make this a somewhat unattractive alternative, although this is the arrangement of choice in many other states. Also, the tax benefits that you enjoy as an owner may not be totally available.

So run these ideas by your CPA and then let me know what you decide.

Q: I am fascinated by your columns on water and water law. Can you recommend any good books?

A: I wish I could. There are several that chronicled the historical dates and regurgitate sterile legal rules, but none that give the full color of what was happening, in building the reservoirs and ditches and putting together organizations like the Northern Colorado Water Conservancy District. The lobbying, political maneuvering and intrigue at the national and state level against Colorado lead by countries like Cuba, sister states, and the sugar interest groups from the Territory of Hawaii, were often Byzantine, bitter, and occasionally violent. There were social and ethnic clashes, between Horace Greeley's "Go West Young Man, Go West" crowd and those Germanic wanderers who somehow found their way here from the other side of the world, fleeing for religious freedom and away from the beheading and raping Cossack persecution. The Colorado water story also has heavy elements of the have/have-not split, such as people trying to break the strangle-hold of those that owned the late water and thus could financially make or break any farmer trying to get enough water to finish out a crop.

The story would include how people who in the future would call themselves Coloradoans "stole" the water (violated riparian law which was the governing water law allocating use), "legalized" the situation through boot- strapping techniques such as in our state constitution and laws (which they wrote), and then through marvelous lawyering, got the federal government to accommodate what had happened. Some of this is now coming apart, causing many of us to wish that Colorado still had that solid core of lawyers with us today.

Thus, to understand why the rules are the way they are these and other factors most certainly need to be recognized. Certain of our traditional water rules literally turned on one or two personalities and a few key events stretching from the international and national sphere to state and local areas. Maybe you should write such a book.