Who ya gonna call for help when even a modest starter home costs well into six figures?
Who ya gonna call for a little assistance with that big down payment and all those closing costs?
The answer across the country for increasing numbers of young first- and second-time home buyers is an ancient one: You call Dad, Mom, grandparents and other potentially sympathetic and generous relatives.
In a real estate economy where average home prices in dozens of markets have already risen by 50 percent or more this decade, intrafamily financial assistance packages are becoming more common than ever.
But accountants and tax lawyers say many participants in these arrangements give little or no attention to the important tax- and estate-planning issues they often pose, for both givers and recipients. For example, if parents lend a child money for a home purchase but don't structure the transaction as a mortgage--a loan secured by a legally enforceable lien against the property--the child won't be able to deduct his or her interest payments against federal taxes. That's because even though the loan is purely for buying the house, it is a personal or consumer loan, not a home mortgage as defined in the Internal Revenue Code.
On the other side of the ledger, many parents and grandparents may not appreciate some of the creative estate-planning aspects of helping out with an intrafamily home financing. Thomas Luhn, tax manager for the Bethesda-based accounting firm Bond Beebe, says one way to reduce the size--and tax exposure--of an estate is to lend funds to relatives buying a house, then reduce the principal balance owed on the mortgage year by year through a series of tax-free gifts.
For instance, say your married children or grandchildren need $50,000 to help swing a home purchase. Assuming you're fortunate enough to be able to do so, you hand them the money and structure the transaction as a mortgage secured by the house, carrying a market interest rate. Each year after that, you send your son or daughter a $10,000 gift--free of taxes to either you or the recipient--and the child immediately sends you a $10,000 check as a principal repayment, lowering the balance remaining on the mortgage.
Luhn says this strategy avoids any question that you are canceling or forgiving the $50,000 original debt--a move that could cause the IRS to view the amount as taxable income to your child. Over a five-year period, the $50,000 loan is paid down to zero, and the repayments of principal "are documented with a clear paper trail" that should avoid any problems with the IRS, says Luhn. Meanwhile all interest payments by the recipients should be tax deductible.
Bear in mind that $10,000 is not the maximum you can give free of gift tax. A couple filing taxes jointly can give $10,000 apiece per person per year--a total $20,000 per recipient--free of federal gift taxes.
Generous grandparents and parents can also use their wills to facilitate intrafamily home mortgage assistance. Say you approach your grandmother, a widow, for a loan to help you buy more house than you can currently afford. How to structure the transaction for mutual benefit? First, make certain the loan qualifies as a true mortgage for federal tax purposes. As long as Grandmother is still living, she will receive steady income via the interest payments due from you and your spouse. (She undoubtedly won't hit you with the typical hassles of a commercial mortgage lender, needless to say: no tough underwriting rules, no credit checks, no appraisal, no loan fees.)
Now for the second step: You ask Grandmother to be sure to list your mortgage note as a general asset of her estate, with no provision that it be canceled at her death. When she passes away, the executor of the estate distributes the note to you as part of your share--assuming you're included in the will as a beneficiary of the estate. You then treat the note, which is now your asset, as paid in full. If the lien is recorded at the courthouse, you have it removed. You should owe no taxes on the transaction.
Will intrafamily mortgage assistance become an even bigger trend in the years immediately ahead? Absolutely, say tax experts. Aging baby boomers and their parents are the two wealthiest generations in American history. Thanks to stock market and real estate gains, they've got the capital--and the tax motivation--to help generations X and Y buy the homes of their dreams.
So be nice to your silver-haired parents and grandparents. They could be the best mortgage lenders you'll ever know.