So you’ve decided to get into real estate investing but are nervous about doing it the right way. There are additional complications when you choose to go into business with another investor. Create the right real estate co-ownership agreement by selecting the right ownership type.
We’ll dive into the major types of real estate ownership, the pros and cons of each, and which types might work best for different goals and objectives.
Sole Ownership
Sole ownership of property might be the simplest ownership type to define– there’s just one owner. You often see sole ownership properties used as investment properties for multi-family rentals, retail spaces, and even land.
Because ownership is owned by a single individual, property management becomes more simplified. All decisions rest with one owner. This means the single owner does not have to consult anyone on how they use the property. This includes the use of the property, selling the property, how they deal with tenants, and gifting the property.
The biggest downside of sole ownership is the complicated situation it leaves your heirs. A sole ownership property can only be passed down to a single heir. You’ll likely send your heir through a costly probate process after you pass. Be sure to consult a skilled real estate lawyer when structuring your will if you own sole ownership properties.
Joint Tenancy
Joint tenancy ownership means that two or more people own equal and undivided shares. This means that joint tenants have equal rights to the property, equal claim to property income, and equal access to property use. But they also share (and are liable for) expenses like mortgage payments, taxes, upkeep, and other costs. This type of property co-ownership is very popular– especially among married couples.
When you form a joint tenancy, you must specify on the property deed that this is your arrangement. When doing this, you will also have to set up the right to survivorship. Right to survivorship means that surviving tenants take over ownership of the property. The surviving tenants don’t have to go to probate, and the transition is automatic.
Here’s an example of joint tenancy in action. A father decides to leave his three children the family beach house in his will. He structures it so Mark, Paul, and Mary inherit the property, and it is co-owned under a joint tenancy agreement. Mark dies first, and his shares automatically transfer to Paul and Mary. If another member of the joint tenancy dies, then the remaining owner now owns the entire property.
The biggest downside of a joint tenancy is that you are tied to the other owners. You can’t sell your portion of the property and must all agree to sell simultaneously. (There are exceptions, but they result in a lengthy court process.) You also are tied to the other joint tenants’ finances. If one of the tenants has debts they aren’t paying, bill collectors can use your property for payment through forced sale.
Tenancy in Common
Tenancy in common properties, like joint tenancy, has two or more owners. But unlike joint tenancy, ownership can be split up into different percentages. Let’s illustrate this with an example. You and your friend decide to own a condo in your favorite ski town. You put down more money for the down payment and agree to take on more of the mortgage, so you agree to own 65% of the property. Your friend takes 45%.
Tenancy in common also doesn’t guarantee equal use, rights, or income. So using our ski condo example, you have rights to 65% of the time to use the condo and income from renting it out. Often under tenancy in common, it’s wise to delineate who is in charge of things like upkeep and maintenance.
Tenancy in common also comes with zero survivorship rights. This means your heir will inherit your share of the property rather than the current owners. They become part of the tenancy in common agreement after you pass. So be sure you update your will or trust if you enter a tenancy in common agreement.
Read our complete guide to tenancy in common here.
Tenancy in Common vs. Joint Tenancy
There are many differences between tenancy in common and joint tenancy:
- You can own different percentages under tenancy in common. This appeals to people putting up different amounts of money when buying an investment property.
- Because you can own different percentages with tenancy in common, you also get different rights. Use, rights, and income all depend on the amount you own with tenancy in common.
- You get to pick who inherits your share of the property with tenancy in common. With joint tenancy, your share automatically goes to the other owners.
Both arrangements have their own unique sets of pros and cons, and you must evaluate which works best for your situation.
Tenants by the Entirety
Tenants by the entirety is a co-ownership situation that is unique to married couples. Both couples own equal shares in a property and have equal claims to all income generated by that property.
Right of survivorship exists with tenants by the entirety. This means that if one spouse dies, the other spouse automatically gains full property ownership.
There are a few ways to get out of a tenants by the entirety agreement:
- Both people can agree to sell
- Divorce converts the agreement into a tenants in common agreement
Tenants by the Entirety vs. Joint Tenancy
Tenants by the entirety sounds very similar to joint tenancy. Let’s breakdown the key differences:
- With tenants by the entirety, you must be married.
- With tenants by the entirety, you own equal shares, but they are divided 50/50. With joint tenancy, you own equal and undivided shares.
Tenants by the entirety agreements allow you to maintain individual (but equal) shares of ownership. While joint tenancy makes it hard to break ownership apart, as our beach house example explains, it is perfect for keeping a property in the family.
Owning Partnership (LLC)
An owning partnership, known as a limited liability company (LLC), allows owners to separate their real estate holding from their personal assets. You are officially differentiating your investment property from your personal assets by labeling it a separate company.
The biggest reason people do this is to reduce risk by limiting liability. You protect your personal assets from lawsuits. So if someone gets hurt on your rental property, you are not liable under an owning partnership agreement.
Owning partnerships also benefit from pass-through taxation. The LLC pays no taxes. Income is passed through to owners’ personal tax returns. This creates a simpler process for individuals who just have a few properties because they aren’t required to do taxes for their LLC.
Owning Corporation
You can use an owning corporation to structure a co-ownership agreement for your investment property. Like an owning partnership (LLC), you are separating your personal assets from your real estate property. But you do have ownership liability. You will be more vulnerable to being sued and should consider getting liability insurance.
Consult a real estate attorney before establishing an owning corporation because the process is more complicated and is not the right fit for everyone.
Owning Trust
In an owning trust, a trustee manages real estate assets for a trustor. Often the trustor sets up an owning trust because they have designated beneficiaries. (These could be children or individuals who are mentally incapable of managing the property.) If the trustor dies, the ownership interest is passed to the beneficiaries.
Owning trusts can be set up in two ways:
- Irrevocable trust: The beneficiary permits the trustee to modify or end the owning trust.
- Revocable trust: The trustor is the only entity that can change a trust.
Besides being a way to own and manage property for individuals who otherwise can’t, an owning trust provides property owners with privacy. You can remain anonymous with no public record. (Note: Privacy is not 100% guaranteed because the court can unseal property records but typically doesn’t.)
Choosing a Property Ownership Type
Before entering into a co-ownership agreement, it’s best to consider your personal situation. You should also consult a trusted real estate attorney that practices in your state so they can consult you on specific laws that are relevant to your situation.
Here are a few questions to consider when choosing a property ownership type:
- Will I own a property with someone else or a group of people?
- Do you want a separate share of a property, or do you prefer equal shares?
- Who do you want to inherit the property?
- Do you want equal rights to the property?
- How much liability protection do you need?
