Borrowing from parents to buy a house still has tax implications
As featured in The Washington Post
I’ve seen articles written by you and others that discuss loans to children who are buying a house and if the contribution exceeds the maximum allowed to avoid reporting it as an excess gift (I think it is $14,000 allowed for each parent).
My understanding is that if you exceed this threshold that you just need to file a gift tax form with your taxes. As long as you haven’t given in excess of the lifetime maximum ($5,340,000) there is no tax due.
Since there aren’t very many of us who will pass on that amount unless we hit the lottery, making it into a loan would only hurt the credit limits of the child and mean you’d need to report the income on your tax return.
We think there are two different scenarios at play in your question. The first is when parents want to give money to their children so that they can buy a home or for the home’s ongoing expenses. The other is when the parents want to help their children, but don’t want to give them the money and would rather have them borrow the funds.
Either way, a deal can be constructed that meets everyone’s needs.
You are right that most people will never hit the gift limit and filing the gift tax form with their federal income taxes might not be a bad option. But the real issue is whether the parents want to give a gift or they want to do a loan.
Some parents are happy to give their children money to buy their first home or subsequent homes, and for these parents the gift route is perfectly acceptable. But in some cases, parents may give one child one sum of money for their home purchase and may give another child a different amount. In these cases, the parents may want to treat their children equally and have the money come back to the parents upon their death and then have their money (the parents’ money) distributed equally to all of their children.
And, in other cases, the parents have the cash but need to keep it to live. They can still lend the money and earn some interest on the loan. The parents may need that interest, and they are still doing their children a favor. The interest rate on the loan may be lower than what the children could get with a loan from a residential mortgage lender, and the parents will probably earn more from the loan than they otherwise would by putting the money in the bank or riskier investments. For these situations, the parents and children both win.
A final scenario is that the parents are trying to teach their children a lesson.
Given that it depends on what the parents’ and children’s needs might be, we can’t say that one way is better than the other. It really would just depend on what they all want and how they want to come out in the end.
On the income tax front, if the parents lend money to their children, the parents will pay income tax on the interest payments and the children will get to deduct the interest paid if the loan is documented properly for the purchase of a home. If you think about it, the parents’ tax bracket may be lower than their children, so they may get more from the deduction than the parents will pay income on the interest.
Hope this clarifies the differences people go through in deciding how to proceed with their kids. For more details, please consult with a tax preparer.