Shared Appreciation Mortgages: The Good, The Bad, and Tax Implications

Article Summary:

Shared appreciation mortgages (SAMs) provide an alternative to traditional home mortgages. This article will describe the different types of SAMs and compare them to traditional mortgages. It will then discuss shared appreciation mortgages’ tax implications and contrast this with the tax implications of shared equity financing.

Shared appreciation mortgages are sometimes confused with home equity investments. They sound similar but are completely different products. Here is an in-depth guide on shared appreciation mortgages, how they work, how they differ from shared equity contracts (another term for shared equity agreements), and where and how to find the best investors.

Back in the 1990s, two banks in the UK gained notoriety with a creative style of mortgage agreement. In order to obtain interest-free home equity loans, various older homeowners signed agreements entitling the banks to large portions of any increase in their homes’ values. The loans these homeowners took out were for a fraction of that value.

The homeowners discovered that as their homes rapidly appreciated, the percentage of their burgeoning values that belonged to the banks grew. So, for loans that were small in comparison to their homes’ worth, these owners had entitled more financially and mathematically savvy bankers to receive far more profit from any future home sale than would the owners themselves.

Clearly, the sort of home loans these homeowners agreed to involved downside risks they failed to consider. What type of loans were they? Shared appreciation mortgages, what we in the colonies often call “SAM loans.”

Cautionary tales from 1990s Britain aside, shared appreciation mortgages (SAMs) are just another variety of real estate financing. Except for being born wealthy and buying all your homes for cash, all varieties of real estate financing have drawbacks that must be weighed against their advantages. SAM loans are no different.

For help tapping into your home equity without making the sorts of mistakes these British borrowers made, read this SuperMoney article.

What exactly is a shared appreciation mortgage (SAM)?

A shared appreciation mortgage, also known as a SAM, is a mortgage where the lender provides a below-market interest rate in exchange for a share of the profit when the house is sold. Shared appreciation mortgages usually have a relatively short term for repaying the principal (for example, 10 years).

Nowadays, shared appreciation mortgages are pretty rare. They are mostly offered by housing authorities and city governments to help families purchase a home. In such cases, they are also called shared equity homeownership. Organizations that offer homeownership programs, such as One Roof Community Land Trust in Duluth, Minnesota, and San Francisco’s Below Market Rate Ownership Program, use shared equity mortgages to give communities access to affordable homeownership to low-income families

Confusing terminology warning: Understandably, shared equity mortgages are often confused with home equity investments or shared equity contracts. But shared equity mortgages are SAMs.

The basic idea of shared appreciation mortgages

Say you’re a home buyer or refinancer. When you get a shared appreciation mortgage, you agree to give your lender some percent of your home’s future appreciation in exchange for better loan terms. This usually means a lower interest rate and lower monthly payments.

Lower interest rates and lower monthly payments are not the only improved terms borrowers have accepted in exchange for sharing their homes’ appreciation. Homeowners who’ve bought near market highs then found themselves underwater on their mortgages have agreed to share their homes’ appreciation. In exchange, they’ve gotten new mortgages based on their homes’ lowered market values. Lenders in these cases have taken on a temporary (and deductible) loss in the expectation that they will gain more in shared appreciation than they write off when reducing the loan amount.

So, some homeowners have signed on to shared appreciation mortgages to reduce their loan amounts instead of defaulting on their underwater mortgages. Even so, SAM loans have never become popular with typical residential owners of single-family homes in the United States. In a 2014 editorial, Kerri Panchuk observed that “the catch-on rate” for shared appreciation loans was “lackluster, despite a strong push for it in the years following the housing meltdown.” (Source)

Shared appreciation mortgage vs. standard mortgage

Though lender-protecting and other stipulations may complicate the picture, the basic difference between a SAM loan and a standard mortgage is in what happens when you sell or refinance your property.

Whichever type of mortgage you have, you pay your lender the principal borrowed plus agreed-to interest over the term of your loan. In the case of a standard mortgage, your obligation to the lender ends there. If you sell while you still owe money, your outstanding balance will be paid out of the proceeds. If your home has appreciated since you purchased it, you may net a tidy profit from your sale and find you can now afford a larger, better home.

SAM Vs. Mortgage example

Imagine that a few years from now, you borrow $500,000 for a modest home in San Diego, California. To make calculations easy, let’s say you finance all $500,000. After paying off your mortgage, you sell the property for $1,000,000 during the latest California housing bubble. The 100% profit is yours to keep. Now compare that with a similar scenario with a SAM. Imagine that your future self takes out a SAM loan to pay for the home. In exchange for a lower interest rate and lower monthly payments over the term of your mortgage, you agree to give your lender 20% of your home’s appreciation when you sell. When you then sell your home for a cool million, you’ll owe the bank 20% of the $500,000 increase in your home’s value. After giving $100,000 to your bank, you’ll be left with only $400,000.

That $100,000 share of the appreciated value you owe your lender is called the contingent interest. That’s the percentage of your home’s appreciated value that you agree to share with your lender in a SAM. It is your lender’s interest in your property, and it’s contingent upon the value of the property at the time of sale.

Were the better terms your future self got worth $100,000? Would you do your future shared appreciation mortgage agreement over again if you got the chance?

Whatever stipulations may complicate your shared appreciation mortgage, you’ll have to pay the full principal and accrued interest in any case. The accrued interest is the lower rate you received in exchange for a share in your home’s appreciated value. This interest is not contingent.

Lender-protecting stipulations of shared appreciation mortgages

You’ll usually pay the share of appreciation you owe the lender when you sell the house. To avoid the risk of never getting their share of your home’s increased value, lenders may stipulate some percentage payment they’ll receive if you do not sell within a certain number of years.

In this case, the appreciated value will be determined by an appraisal rather than a sales price. This could result in having to make a very large payment to your lender all at once.

Imagine this. Ten years after your home purchase, your lender sends over an appraiser to determine the home’s current value. Home prices are up, and the appraiser determines that your home is now worth $100,000 more than when you bought it. Since your loan agreement stipulates that your lender is entitled to 20% of your appreciation if you haven’t sold in 10 years, you get a bill for $20,000. If you haven’t set that much money aside, your only recourse may be to accept a refinancing arrangement at a higher interest rate.

What happens if house prices drop?

Lenders may even stipulate a minimum amount due them based on their projection of your home’s future value, an amount due even if the home increases less in value than projected or declines in value. In this scenario, at the end of the same 10 years, you sell your home for $20,000 less than what you paid. Thanks to your loan payments over the years, this drop in home value hasn’t left you entirely without equity. You’re not going to come out of the deal with enough money for a comparable new home, but you think you’ll be okay. Downsizing to a condo could be fun.

Then your bank reminds you that you still owe them $20,000, 20% of the $100,000 they projected your home would increase in value over those years. Lucky for you, van conversions are a thing again. There’s no shame in being a nomad.

Other stipulations of shared appreciation mortgages

Not every stipulation on SAM loans necessarily benefits lenders. A shared appreciation loan might include a provision phasing out the appreciation sharing after some number of years. Such a “phase-out clause” might start reducing the lender’s share of appreciation (the contingent interest) starting at year 5. Perhaps a 20% share could drop 4% a year from years 6 through 10. After year 10, borrowers who sold or refinanced would not have to pay any share of their property’s appreciation to their lender.

A SAM could also phase out appreciation sharing all at once. Homebuyers might agree to share appreciation only if they sold their homes within, say, 5 years. If they sold after that, they would not need to share any portion of their property’s appreciation. In this and the prior arrangement, lenders’ would be using shared appreciation to compensate for the reduced profit from accrued interest resulting from quick resales.

Shared appreciation mortgages for real estate investors

Seeing the complications that can arise, you may begin to see why shared appreciation mortgages in the U.S. have yet to become wildly popular among long-term owners of single-family homes. For most American borrowers, SAMs are an interesting alternative rather than the mortgage loan of choice.

In places like the U.K., where government involvement in the housing market is pervasive, the situation is quite different. Government programs in such nations often use shared appreciation loans in programs for first-time homeowners. Whether advocates of such government programs in the U.S. will ultimately win the day remains to be seen.

U.S. real estate investors have already recognized the usefulness of SAMs.

SAMs and house flipping

If you’re a house flipper who buys homes, quickly fixes them up, then sells them at a higher price in a rapidly rising real estate market, shared appreciation mortgages may work well for you. By sharing some of your profit on each home with your short-term mortgage lender(s), you may be able to flip more homes than you could finance otherwise.

You and your lender would be team investors, working together to make money quickly while prices are rising. It’s a win-win.

And, should you get stuck with a home you meant to resell quickly, a phase-out clause might make the mortgage loan’s unexpected longer duration bearable.

To learn about specific shared appreciation loan programs that might be right for you, review our best-of listing. If you’d like to learn more about the range of mortgage options lenders like you are currently using, check out this study.

What are the shared appreciation mortgage tax implications?

Maybe you’re a new homeowner who could only afford a home with the terms and annual percentage rate available with a SAM. Maybe you were underwater on your mortgage and could only avoid default with a shared appreciation mortgage. Or maybe you’re a seasoned house flipper who’s using SAM loans for real estate investment.

Whatever your situation as a SAM borrower, you’ll have to deal with some tax consequences. And if you’re just trying to decide if a SAM might be the right home loan for you, you’ll need to know about the tax treatment of SAMs to make an informed choice.

SAM taxes bottom line: consult a professional

If the above overview has made one thing clear, it’s that shared appreciation loans can get complicated. At the same time, the ever-growing complexity of the U.S. tax code is well known.

So let’s state the bottom line first: Before getting a shared appreciation mortgage, consult a tax professional. This isn’t the time to do it yourself.

Tax issues when SAMs include a principal reduction

As noted earlier, some borrowers have signed SAM loan agreements in order to get their loan amounts reduced. This involves what is called a principal reduction.

A tax difficulty arising from this sort of SAM is that a principal reduction gives the borrower what the U.S. tax code calls cancellation of debt income (CODI). It is taxable like other income. That SAM borrowers can end up paying some or all of this “income” back as shared appreciation doesn’t change this.

This is an issue only for SAMs involving principal reduction. (It is also an issue for many short sales.) Arrangements involving only lower annual percentage rates are not affected.

Or should I say this was an issue?

SAMs and the Mortgage Forgiveness Debt Relief Act

In December of 2007, a temporary federal measure, the Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110-142), excluded qualifying canceled mortgage debt from CODI taxation. The original act covered debt discharged before 2010.

In possible confirmation of Ronald Reagan’s quip that there is nothing more permanent than a temporary government program, the temporary 2007 exclusion has been extended repeatedly, most recently as part of the Consolidated Appropriations Act of 2021 (P.L. 116–260). Still officially temporary, the exclusion is now set to expire at the end of 2025.

How does the SAM tax exclusion work?

This exclusion applies to “qualified residential debt,” meaning debt that is:

  1. No greater than $750,000 ($375,000 if married filing separately). Any debt over the limit still counts as taxable income. This limit was lowered in 2021. Before the Consolidated Appropriations Act of that year, the limit was $2 million ($1 million if married filing separately).
  2. Taken on to buy, build, improve, or refinance the taxpayer’s main residence, which residence secures the debt. Excess refinancing, such as “cashout financing,” does not qualify.

The exclusion does not apply to debt discharged in compensation for services or on the basis of anything other than a decline in the property’s value or worsening of the taxpayer’s financial situation.

Tax issues with other SAMs

Discussions of shared appreciation mortgage (SAM) tax issues always seem to focus on SAMs with principal reduction. Often, authors speak of SAMs as though they include such reductions by definition. (They don’t.) Through the end of 2025, ordinary owners of single homes do not seem to have much cause to worry about the effects of principal reduction on the tax treatment of shared appreciation loans (for primary residences). Of course, cases must be considered individually, and concerned homeowners should always consult a tax professional for the most current and comprehensive guidance.

SAMs with principal reductions aside, do any tax concerns arise from SAMs that do not involve principal reductions? Does paying an annual percentage rate lower than the market rate have any tax consequences? What tax relevance does the borrower’s shared appreciation payment upon sale or refinancing have?

Contingent interest and taxes

Normally, the contingent interest (shared appreciation) paid to your lender when you sell or refinance will be deductible like other mortgage interest. If your shared appreciation mortgage has a lender-protecting stipulation that requires you to pay contingent interest though you are not selling or refinancing, the interest would still be deductible.

Since lenders and borrowers are at liberty to negotiate interest rates on their loan agreements, your acquiring a loan at an interest rate below the market rate should not have tax implications beyond reducing your mortgage interest deduction (because you pay less interest).

While the preceding should be true of typical SAMs, you should always discuss your specific SAM with a qualified tax professional if at all possible.

Tax issues with SAM lookalikes

In the 1983 IRS Revenue Ruling 83-51, it was decided that a shared appreciation mortgage must stipulate an unconditional obligation of payment of principal to avoid being recharacterized as an equity-sharing agreement. Given how long ago this ruling was issued, it seems unlikely any competent mortgage lender will set up an intended SAM that turns out to be an equity-sharing agreement. Still, a brief look at the tax implications of this other sort of agreement may be worthwhile.

Equity-sharing agreements, also called shared equity financing, have some similarities with shared appreciation loans or SAMs. Each involves a second party helping a first party buy or occupy a property in exchange for later payment by the first party to the second. And in each case, that later payment is based on property value.

In a SAM, the assisting second party is usually called a “lender.” The assisting party in an equity-sharing agreement is more often termed an “investor.” While in a SAM the first party acquires purchase assistance through better loan terms, the assistance received in an equity-sharing arrangement is usually cash, such as for a down payment. And first parties in equity-sharing agreements might or might not have ownership stakes in the properties before meeting their obligations to (paying) second parties.

Home equity investments and taxes

The variety and complexity of equity-sharing agreements equal or exceed that of SAMs. Attorney Andy Sirken, who’s been structuring equity-sharing agreements since 1985, summarizes the tax implications of these agreements as follows.

“Even with a good shared equity financing contract or option agreement, there are varying levels of income tax risk associated with the different equity sharing legal structures.”

Tax implications of having investors and lenders on the title

“In general, having both the investor and the occupier on title is the least risky shared equity financing structure from an income tax perspective and also offers the maximum possible income tax treatment flexibility and advantages for the parties,” says Sirken. However, home equity investments will usually keep investors off the property title.

“The next best option is having only the occupier on title, and styling the investor’s position as an option or similar financial instrument,” adds Sirken. “The least desirable equity sharing structures from an income tax standpoint are those where only the investor holds title (meaning the occupier is not an owner named on title), or where an LLC or other legal entity holds title. These structures deprive the occupier of homeownership tax benefits and create significant risks of adverse tax characterization, especially at the conclusion of the equity share.” (Source)

If you’re intrigued by the whole idea of shared-equity alternatives to traditional home financing, you should read this SuperMoney article.

Regardless of your financing, your home purchase will expose you to another tax: property taxes. To learn how you might be able to save on these, read this article.

Concluding Remarks

More than one borrower who’s purchased or refinanced a property with a shared appreciation mortgage (SAM) has later regretted it. The terms of these loans vary widely, and some SAMs have had terms so bad for borrowers that they’ve made international news.

At the same time, some homeowners have avoided defaulting on underwater mortgages through SAMs. As well, real estate investors, from small-time flippers to Real Estate Investment Trusts (REITs), have found shared appreciation loans a valuable financial tool.

Thanks to legislation in effect through at least 2025, tax treatment of shared appreciation mortgages no longer carries the risks it once did. Provided they are properly structured, SAMs provide the same tax benefits as standard mortgages during loan repayment. As well, the shared appreciation you owe your lender when you sell or refinance, called contingent interest, will normally be tax-deductible.

That said, SAMs are complex financing arrangements best entered into only after careful due diligence and consultation with professionals who specialize in them.

View Article Sources
  1. BBC Inside Out South: Shared Appreciation Mortgages, an investigative piece by British journalist Nick Wallis – Nick Wallis YouTube channel
  2. Compare Different Types of MortgagesState Farm
  3. Questions and Answers on Equity Sharing — Sirkin Law APC
  4. The blessing of shared appreciation — HousingWire
  5. Shared Appreciation Mortgage (SAM) — Investopedia
  6. Shared Appreciation Mortgages — Edspira (Michael McLaughlin) YouTube channel
  7. The Tax Treatment of Canceled Mortgage Debt — Congressional Research Service