How To Give Adult Children Money For A Home, And Avoid Tax Problems

Often, parents help out their young adult children in buying that first home, via a loan. Bruce Bell, an attorney at the Chicago office of Schoenberg Finkel Beederman Bell Glazer explains how to do so.

Larry Light: Let’s say my spouse and I lent our daughter and her husband the full amount needed to purchase the dwelling. None of this was documented. What should we be doing to minimize the tax bite and keep things legal?

Bruce Bell: There are a number of factors you and your spouse should consider—and your daughter and her husband, too

Let’s presume your intention is to be repaid. The loan should be documented by a written promissory note. The note should reflect the amount borrowed, the interest rate, the terms of repayment and other key provisions. The loan interest rate can either be a fixed rate or can be a floating rate based on some benchmark, such as a specified prime rate of interest. And it should be payable in periodic intervals. 

While the intervals can provide for annual, quarterly or monthly payments, most home mortgage loans are paid on a monthly basis. The interest should be set at a rate no less than the IRS prescribed rate of interest so the loan is not treated as a below-market loan, which could trigger taxes.  

Light: What’s the tax vulnerability?

Bell: Gift taxes are the issue here.  If there is no promissory note and the Internal Revenue Service investigates the transaction, the IRS could treat the transaction as if it were a gift, and this could impact you from both a gift tax and an estate tax perspective. Gifts valued above $15,000 in 2020 and 2021 can be viewed as taxable.

Light: And what if, God forbid, our daughter dies?

 Bell: You may have no intention for your daughter and her husband to repay the loan. But you may think differently if your daughter were to die before you or your spouse. The gift could ultimately end up in the hands of your son-in-law. A related concern could arise if your daughter and her husband were to divorce, lest some portion or all of the home equity could affect the division of their property. All of these issues should be carefully thought through beforehand.

Light: Banks have a whole bunch of tests for prospective mortgage holders. Should we take such steps?

Bell: Yes, conventional third-party lenders to home loan purchasers require a borrower to procure title insurance, obtain a survey of the property, undergo a credit check and jump over a number of hurdles before funds are made available. While many of these steps are not undertaken in a parent-child loan, you might look at taking some of them to protect your interest.

Light: What tax-oriented moves should our daughter and her husband make regarding this loan, so they can deduct interest on their loan repayments to us?

Bell: Most importantly, the loan must be secured by a mortgage on the property, and the mortgage must be recorded with the local recorder of deeds. If this requirement is not satisfied, your daughter and husband will not be able to deduct any mortgage interest on the loan from you.

Light: What if we already gave them the money and they’ve purchased the house? Is it too late?

Bell: There may still be time. To comply with interest tracing rules and to establish that the loan relates to the home purchase, the loan documentation must be put into effect within 90 days of the home purchase.  Also note that only interest on up to $750,000 of mortgage debt can be deducted as home mortgage interest.

Light: Simply giving kids some money to better their lives is involved, isn’t it?

Bell: On the surface, a parent-child loan is a relatively simple arrangement. As with many family dealings, however, these transactions tend to have various twists and turns that many people do not consider. By following all of the specific requirements, you can adequately protect your economic interest and you and your daughter’s tax considerations.