DEAR BENNY: Our son and his wife want to buy a $600,000 condo and we are prepared to assist. In fact, we are considering lending them all of the sales price. Is this something we can do and avoid any IRS issues? – Calvin
DEAR CALVIN: You and your wife are to be commended for this, but let’s make sure that you do it right.
First, if you want, you can give them some of the money. The annual exclusion for gifts is $14,000 per person; thus, you and your wife can give both of the young ones $56,000 this year. In fact – if you want to – you can gift them $56,000 before the end of this year and another $56,000 early in January 2016.
Under tax law, if you are going to loan more than $10,000, you have to charge interest. Go to “Applicable Federal Rate” (AFR) on the web; each month, the IRS provides various prescribed rates for federal income tax purposes. You are OK if you complying with the AFR rate.
Otherwise, if you do not charge interest – or if the rate is below the AFR – you will have to pay what is known as an “imputed rate”determined by the IRS; I call it “phantom interest” because you have to pay the IRS on money you are not receiving.
I recommend you retain local counsel to guide you through the process. Ethically, that attorney cannot represent you and your son and daughter-in-law, so they may want to consult their own counsel.
You will have the couple sign two important legal documents. The first is a promissory note, which is the IOU that is signed and spells out the amount of the loan, the interest rate, the expiration date, and information as to what happens if they are in default. The second is a deed of trust, which in some states is called a mortgage document. Here, the couple will deed in trust the condo to a trustee you will select, and that document will be recorded among the land records in your county or city. The trustee has one of two functions: release the trust from land records when the loan is paid off, or foreclose on the property if there is a default.
Why would you want to have a deed of trust? From your point of view as the lender, it protects your money should your son go into bankruptcy or have a judgment against him. And while we don’t like to think about such things, there may be a divorce, and this way there will be no question that you are owed the money.
But recording a deed of trust benefits the couple also. If there is a recorded document, the borrowers can deduct for income tax purposes the interest they are paying. If the deed of trust is not recorded, they cannot take those deductions.
Your attorney should be able to walk you through the steps.
DEAR BENNY: I am 83 years old and in poor health. I own a condominium worth about $400,000, with a mortgage of $76,000 and a home equity loan of $76,000. Will my son be able to assume those loans after I die? His credit is not good. But if he can take over those loans, the amount he currently pays in rent will be approximately the same as the payments on those loans. – Conchita
DEAR CONCHITA: Yes, your son will be able to assume the two loans. Most current loans have what is known as a “due on sale” clause, which simply means that if you transfer title to anyone, the bank has the right to call the entire loan immediately due and payable. But back in 1982, Congress enacted the Garn-St.Garmain Act, which does not allow lenders to call loans due based on a number of situations. One such situation is a transfer to a relative resulting from the death of a borrower.
But property ownership, even in a condo, can be more expensive then renting. For example, did you factor in the condo fee you have to pay? What about insurance? What about special assessments that the association may impose down the road?
You and your son should sit down and do the numbers; be realistic. If he can’t afford the condo, he can sell it after your death. He will get the stepped-up basis, so if he sells if for $400,000, he will not have to pay any capital gains tax. By your calculations, not including selling costs such as real estate commissions or seller credits, he should be able to walk away with at least around $250,000.
Benny Kass is a practicing attorney in Washington, D.C. and in Maryland. He is not providing specific legal or financial advice to any reader. He wants readers to e-mail him, but cannot guarantee a personal response. He can be reached at: email@example.com.