One of the best gifts is to help an adult child or grandchild buy a home.
Unlike cash or investments, a gift related to a home cannot easily be squandered or sold to buy something frivolous. When the child or grandchild is making a significant contribution from his own assets through at least future mortgage payments, the house is likely to be cared for. Of course, in most areas the home is likely to appreciate. Don’t count on the rate of appreciation that we’ve seen on the coasts and in resort areas for the last five years, but count on the value at least keeping pace with inflation over time.
Helping adult children buy a larger home might make it easier for you to visit the grandkids more often. Or the gift might enable the family to buy in a better neighborhood with better schools, helping the grandkids get ahead in life. You also know that your help frees up cash for the family to spend on other things. Helping with a home might prevent the family from having to tap a 401(k) or IRA plan to buy the home.
The tax law encourages these kinds of gifts.
The estate and gift tax law encourages you to make substantial gifts now.
The estate tax is based on the value of an estate. If you hold assets for life, both their current value and future appreciation will be in your estate and subject to taxes. Give some of the value now, and the future appreciation is out of your estate and escapes taxes.
The gift tax also encourages gifts.
Each person has an annual gift tax exemption currently set at $11,000 per recipient annually. A married couple can give $22,000 jointly to a person tax free each year. That means a married couple can give their married son and daughter-in-law $22,000 each in December and another $22,000 each in January, for a total of $88,000 over the two months.
In addition, gifts above the annual exemption have a $1,000,000 lifetime exemption per person. That means this year you can give the annual gift tax amount plus the $1,000,000 lifetime exemption and owe no gift taxes. Your spouse can do the same.
You should be able to help a child or grandchild purchase a home without triggering gift taxes, and the gift likely will reduce estate taxes. If you have more than one adult child and help only one, your will can adjust their inheritances for any significant lifetime gifts.
The first decision you have to make is how much to give, and exactly what costs you want to help with. Some give primarily the closing costs. In many areas these are substantial, especially when sales or recording taxes are based on the value of the home. Others also help with the down payment. Of course, some families are able and willing to help with all or a substantial portion of the purchase price.
The next decision is how to provide the help. There are a number of options.
The easiest and most common strategy is a gift accompanied by a gift letter. The letter assures the mortgage lender that you made a genuine gift with no strings attached, not a loan you expect to be repaid. Most lenders require buyers to make a minimum down payment from their own assets. They require a gift letter if the borrower recently received a substantial gift.
Another option is to co-sign the mortgage. Essentially you are lending your credit rating by signing the mortgage. You put up no cash by co-signing.
There are several potential downsides to co-signing. If the child or grandchild stops making payments for any reason, you are obligated to step in and continue them. Then, you are in the uncomfortable position of deciding what to do about the child or grandchild. Do you buy him out? Try to foreclose and sell the house? Continue payments until he is able or willing to?
Other problems can occur if the child divorces his or her spouse. You and your interests become part of the divorce proceeding.
By co-signing, you also are putting your credit rating at risk. The child or grandchild might get far behind on the mortgage and near foreclosure before you hear about it.
Equity sharing is a similar option. The tax effects of co-owning can get complicated. You will need a good tax advisor to walk you through the different ways co-ownership could be structured and the tax implications of each. You have to discuss issues such as how much of the down payment you will contribute; how much of the monthly mortgage and real estate taxes you will pay; and how much rent the child or grandchild might pay you. Who will pay the real estate taxes, maintenance, and other upkeep? Who has responsibility for other expenses? How will appreciation be shared?
It usually is better to opt for one of the simpler strategies. A good rule of thumb is: Help only to the extent you can afford simply to give the money, regardless of how you structure the help. If you need an equity interest to be comfortable, you probably are giving too much.
You could make a low-interest or no-interest loan to help buy the house. But this probably won’t help unless you buy the house, sell it to the child or grandchild, and finance the purchase with a low-interest loan. As I said, mortgage lenders generally require buyers to put down a minimum amount from their own unencumbered resources. A loan that the parents or grandparents expect to be repaid will not qualify.
With the loan, you also have all the potential problems of which actions to take if the child or grandchild stops making payments. We’ve discussed the tax rules for low-interest or no-interest loans in past issues. They are in the Grandkids’ Watch section of the Archive on the web site.
There are many ways you can help a child or grandchild buy a home. You need to start early. Decide how much money you are willing to contribute and which strategy you want to use.