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April 11, 2006: Co-Signer Options

Q: We merely co-signed on our son and his wifeÕs note so they could purchase a home. Title was placed in joint tenancy with all four of us. But we really were not involved in making the down payment or the making of the monthly payments. Should we just quit claim our interest in the property to them?

A: There were a number of ways to handle this arrangement but let us focus on the way you decided to set this up, even though I would not have recommended this approach.

You gave something of value, your credit. Without it your son and his wife could not have purchased the house and if you try to borrow additional money, your commitment could affect your ability to qualify for future loans.

Now an argument can be made that your holding title is just an accommodation, or a nominee arrangement, or a "resulting trust," since you claim no interest in the equity. But the fact remains that you have an equity position that you decided to establish, which arguably was to protect your credit, share in profits, etc. Thus it would be up to you to prove your position in Court that you have no legal interest, something that might be very hard to do in tax court since the burden of proof would be up to you to convince the court of what you intended.

Capital gains exposure will affect all four of you. By being on title it is presumed, unless established as previously mentioned, that any capital gain would be allocated to your percentage share of ownership, thereby causing you to pay the appropriate tax, and your son and daughter-in-law would only be able to shelter capital gains on their part of the house equity if they used the property as their principal residence two out of the previous five years.

Besides capital gains problems, you may have income tax problems. Some, but not all, CPAs feel that you must report "rent" from your son and his wife on your part of the house, even if none is paid, but you would be entitled to receive deductions, and possibly other expense deductions.

There are any number of additional tax and legal concerns. But due to lack of space, letÕs address your suggestion of just quit claiming by deed your interest in the property to them to get out from under possible tax ramifications.

If your share of the equity at this point was less then $48,000, each of you can "gift" $12,000 to each of them. If greater then $48,000, gift taxes can be avoided but the appropriate gift tax forms would need to be filed.

But legally there are many other land mines besides gift taxes that are present in such a transfer. You are still bound to pay off the note. Unless the mortgage company agrees, transferring the house will not release you from that obligation. Some aggressive mortgage companies might even claim that such a transfer triggers the "due on sale" clause, thereby causing the entire loan to be due and payable. Although I think that this position is wrong, much time and money might have to be spent in the legal fight.

There are certain advantages to remain "on title". For example, to a certain extent being on title permits you to control (or in some cases block) transfers because of divorces, bankruptcies, judgment liens, etc.

But on the downside, if payments are missed, your credit would be affected. If after a foreclosure, a balance is still left unpaid on the note, as a co-signer, financial responsibility can be imposed upon you.

Thus, you have to play the cards that you dealt yourselves by co-signing. The decision at this point as to whether to quit claim the property to the kids is up to you. There are no easy answers.

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