HOW TO HELP THE KIDS BUY A HOUSE

This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

My other article discusses financing.  This article discusses legal issues. 

I assume that for some reason (Son has bad credit or needs help with the downpayment), Mom and Dad have agreed to help out with the money or financing. 

Let's assume: Son wants to buy a new home for $1M; he has $25,000, he can afford the carrying costs; an extra $175,000 to make 20% down would really help him qualify for a better interest rate from BigBank.

Plan 1:  Mom and Dad go on title as Owners with Son, all as Joint Tenants.  Son, Mom, and Dad sign the mortgage with BigBank. 

Joint Tenants is the most popular option, as it avoids Probate Court when someone dies; the property is automatically owned by the other Joint Tenants.  (Joint Tenants requires each Owner owns the same percentage.)  So if Dad dies 1st, Mom and Son own 50-50.  Later, when Mom dies, Son owns 100%. 

Income Tax Deductions:  Whomever pays it may deduct mortgage interest and property taxes.  Son pays and deducts 100%.

Sale:  When the property is sold, Son qualifies as selling his primary residence tax free; Mom and Dad do not so their portion is fully taxable.

Lawsuit:  If a passerby trips and falls, or a neighbor has a boundary line or tree problem, all Owners are involved.

Son's Divorce:  Some families like this structure to reduce the risk in divorce.  If Mom and Dad own 67%, the most the ex-wife can get is one-half of 1/3.  [Note:  This is not the law, but the public's perception of the law.]

Credit:  Mom and Dad's credit is stretched by the BigBank Loan and if Son defaults, their credit is at risk.

Death of Parents:   If Dad dies, 1/2 of the entire property is in Dad's estate, under an odd rule applicable to Joint Tenancy; if Mom dies next, the entire property is in her taxable estate.

Plan 1B:  Same as Plan 1, but Mom and Dad immediately sign Deed to Son giving him 100% ownership.

Income Tax Deductions:  Son pays and deducts 100%.

Sale:  When the property is sold, Son qualifies as selling the entire primary residence tax free.

Lawsuit:  Not Mom and Dad's problem IF Son records the Deed, but if Son holds it unrecorded, they are still Owners on record.

Son's Divorce:  Yikes.  She gets 50%, maybe.  [Note:  This is not the law, but the public's perception of the law.]

Credit:  Mom and Dad's credit is stretched by the BigBank Loan and if Son defaults, their credit is at risk.

NOTE:  It is not relevant for taxation if Son records the Deed on public records or holds it unrecorded.

GIFT TAX:  Mom and Dad made a gift of $175,000 which should be reported to IRS on Form 709.

Plan 2:  Mom and Dad lend Son $175,000 and at purchase, Son signs a 2nd mortgage to them, using the new home as security.

Son has 100% ownership.

Income Tax Deductions:  Son pays and deducts 100%.

Sale:  When the property is sold, Son qualifies as selling the entire primary residence tax free.

Lawsuit:  Not Mom and Dad's problem.

Son's Divorce:  Yikes.  She gets 50%, maybe.  [Note:  This is not the law, but the public's perception of the law.]  But let's follows the $#s, assuming they divorce and split the proceeds.

BigBank is still owed $800,000

Mom and Dad are owed $175,000 + any unpaid interest!

Son and his ex might split the remaining cash

Credit:  Mom and Dad's credit is not affected.

GIFT TAX:  Mom and Dad made a loan, not a gift, and nothing needs to be reported (other than annual interest income).

 Death of Parents:  If Dad dies, 1/2 of the unpaid balance is in Dad's estate; if Mom dies next, the entire unpaid balance is in her taxable estate.

Summary:  I like the parents to be Lenders in this situation.  This makes everything as simple as possible.

For more information on gifting, see:
Advanced Estate Planning
Family Limited Partnerships