Laura Saunders's Tax Report starts from one condition. The family has to trust each other with money. Parents, grandparents and grown kids, all pulling the same way. The 30-year mortgage averages 7.50% in Bankrate's latest survey. The IRS says a family loan longer than nine years only has to charge about 5%. So Mom and Dad can be the bank. The catch is that the IRS wants it done the way a bank would do it.
Start with the loan. It's legal for a family to lend a down payment or to hold the whole mortgage. Ryan McKeown, a CPA with Wealth Enhancement Group in Minnesota, says don't cut corners. Tell the mortgage lender about a down-payment loan, and sign a formal agreement. For a private mortgage, both sides should have a lawyer and a written payment schedule. The lender pays tax on the interest. The rate can't be lower than the IRS minimum, called the Applicable Federal Rate. Right now that's about 5% for loans longer than nine years, about 4.5% for three to nine years and about 4% for three years or less.
Now the family part. The lender can forgive some of the loan each year as a gift. Anyone can give anyone $19,000 a year with no gift tax and no filing. If a married couple lends to a married couple, that's up to $76,000 a year. The borrower owes nothing on it. McKeown has one warning. Don't write a schedule for forgiving the debt. Send a separate letter each time, with the amount, and keep the letters. Without that, the IRS may treat the whole loan as a gift.
Two more tools for families that get along
The second tool is a gift of stock. Gifted shares keep the giver's cost basis, the price the giver paid, so the gain travels with the shares. In the column's example, a well-off couple wants $5,000 in a 529 college plan for each of two kids. Selling about $11,000 of stock at their 18.8% rate would do it. Grandma's rate on the same sale is 0%. Give her $10,000 of shares, she sells and funds the plans, and the family saves about $1,000. Mark Sellner, a retired tax attorney and CPA in Sarasota, Fla., does this with his own children. “There can't be any strings attached to gifts,” he says. Two cautions. The kiddie tax hits most children under 24 on investment income above $2,700. And gifted stock loses the step-up at death, the rule that erases the gain on what you still hold when you die.
The third tool is a disclaimer. An heir turns down an inheritance within nine months, and it passes to the next heir named. In the column's example, Mom declines part of Dad's big IRA, and three adult children get 10 years to empty it. The family likely saves estate and income tax.
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This is Housing (M6) with Tax and Estate wrapped around it. The one point is that family money can stand in for a 7.50% mortgage at about 5%. It only works with a signed agreement, a rate at or above the IRS floor, interest the lender reports, and forgiveness done one letter at a time. One note for our Shariah-screened readers, and this one is our observation. To stay clear of the IRS, the loan tool has to charge interest. The interest-free tool in the same column is the annual gift. A CPA or an estate attorney should paper any of the three.
Set this up before the house hunt, while everyone is calm. Write the terms, pick the rate, and decide who tracks the payments. A loan drawn up in a hurry at closing is the one that draws questions later. You fix the roof in dry weather. Bring the idea to your next review, with the CPA on the call.