We don’t know if your mom will be charging you interest on the loan. If your mom doesn’t, the IRS will treat the arrangement as a gift from your mom to you. The gift amount is based on the amount of interest you would have paid your mom each year.
The IRS has tables of interest rates that can be used to satisfy IRS requirements that the loan charge you a fair interest rate, sometimes known as an “arm’s length” interest rate. Those same rates can be used by the IRS to figure out the gift amount. You can find these interest rates on the IRS website under “Index of Applicable Federal Rates (AFR) Rulings.” There you will find minimum short-term, midterm and long-term interest rates that you can use in determining loan payment amounts between family members. The tables will also give you amounts that will exceed the minimum amount by 10, 20 and 30 percent.
If your mom does not charge you interest on your loan, she has the right to give you an annual gift of $15,000 for 2018 ($30,000 if the gift is to two individuals) without triggering gift tax filings. If you paper the file and she decides not to charge you interest, you should make sure you are under the $15,000 annual limit.
You mentioned you are buying this vacation home with someone else. If that’s the case, your mom can give you and this other person an annual gift of $30,000, and she can give you this gift each year until she has basically given you the property. As we mentioned before, we’d prefer to know you have some paperwork that shows the gift would be to you and the other person. We don’t want you to be in a position where the IRS feels the gift was to you alone and then requires your mom to file gift tax paperwork with the IRS.
If your mother is giving you the home, however, and you do not have paperwork showing the gift was a loan, you should be aware that when it comes time to sell the property, you may walk into a minefield where the IRS determines you essentially paid nothing for the property, so if you sell it you will owe a great deal in capital gains tax.
In general, if the home is owned by you and used as a second home, you can deduct the real estate property taxes and may be able to deduct your interest payments you make to your mom. You’ll have to see what benefits you get on your federal income taxes by deducting interest and property taxes. (You might also want to keep in mind the tax rules are changing and you may have a limited amount to deduct a maximum of $10,000 for real estate property taxes and any state income taxes you owe.)
But if you have a primary home mortgage and a second home mortgage, the limits used to be that you could deduct interest on a primary loan of up to $1 million and $100,000 on an equity loan. Starting this year, you’ll be able to deduct interest on a loan up to $750,000 with interest on home equity loans no longer deductible. (No worries for our readers who took out loans before Dec. 15, 2017. You are grandfathered in, and there are no change of rules other than the new maximum deduction level for those loans; but if you refinance you will be subject to the new rules.)
So if you have a home mortgage on your primary home of $250,000 and take a loan from your mother for $250,000, you’ll be able to deduct a maximum of $10,000 in interest, state tax and property taxes.
You should also know you will benefit from any future appreciation of the home as you will own it. Your mother won’t share in that appreciation and should not have any tax consequences when you decide to sell the home. But if she charges you interest, that may affect her own income tax form.
Please document this loan to show that the money given from your mom to you is a loan and that your payments to her are repayments on that loan. You should talk to an attorney in your area to help you with the paperwork. You might have to record a mortgage on the second home to evidence the loan and allow you to deduct the interest payments to your mom. Good luck.
Ilyce Glink‘s latest book “100 Questions Every First-Time Home Buyer Should Ask, 4th edition,” will be published in mid-February. She is also the CEO of “Best Money Moves,” an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, ThinkGlink.com.