Tuesday, May 31, 2016

Gift or loan? Parents give kids money to buy a home

A husband and wife may give a child and son/daughter-in-law a total of $56,000 per year without triggering tax issues ($14,000 per donor to each one).

The IRS will presume an interest rate on a loan between parent/child even if there is no stated rate. Thus, the parent may unwittingly receive interest income that is not wanted/needed unless a gift of the interest is made to the child.

Rather than go to a tax preparer, complicated matters such as this should be planned with an accountant or estate planning attorney.

You can't count on a storefront tax preparations service company to consider all the nuances.
We think you are referring to a column where a parent was asking about gifts or loans to children when they are buying a home. You are correct that a father and mother can gift $56,000 in one year to a child and his or her spouse or partner without triggering any tax consequences with the IRS.
However, the issue in the question was whether they could give their kids a loan. Presumably, the parents wanted their kids to pay back the money that they were given toward the purchase of their new home.

Again, there are competing interests when it comes to buying a home and receiving gifts and/or loans from parents. The lender wants to see gifts to the kids with no obligation to repay. The parents may want to see it as a loan. The parents want to get repaid, but the lender doesn't want to see that as an obligation.

The underlying issue is the debt-to-income ratios the children have when they purchase a home. If the children receive the money as a loan, they may not be able to borrow as much from the bank to purchase their new home. From the kids' perspective, if they can't borrow the amount they need from the bank to buy the home, the loan from the parents doesn't help them much.
Lenders want to see parents give their kids the money but also want parents to sign something saying that the parents have given the kids a gift and don't expect repayment. If the kids need money in excess of the $56,000, or the child is buying a home alone, the kid may only be able to get $28,000 from the parents as a gift. If these amounts are not enough to cover what the kid needs to purchase the home and the parents give more than the allotted amount of $14,000 per person per year, the parent may need to file a gift tax form with the IRS.

Having said that, parents can plan ahead and gift money over several years into an account that is in the name of their kids. That amount can transfer to their children and the parent won't have to pay taxes on the gift or file gift tax forms. In addition, the money will be seasoned in the account, and the lender down the line will see that money as the kid's money without any strings attached. So with some planning, the parents' idea to give money to their kids can work to transfer wealth from one generation to the next, and neither the kids nor the lender should have any issues with it.
However, once the money has been given to the child, it's their money to do with as he or she pleases. And, much to the displeasure of the parent, the kid might not make use of that money as intended.
If the parents have their own money but need it for retirement, they will need that money repaid. Once that money is gifted to the kid, the kid won't have a legal obligation to repay the money and will only have a moral obligation to repay the money.

As the situation gets more complicated, and more kids (and spouses and partners) are involved, parents should seek professional help.

The best help comes from estate planners and accountants. We don't usually recommend that people seek help from tax preparation companies that help people fill out forms and file income tax returns, as they may not have sufficient knowledge or experience to advise families on issues that go beyond tax preparation issues.