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I'm sure this is not a unique situation, but my in-laws want to give us a fairly substantial chunk of money towards a deposit on the house, and they want to receive some income from us as a result of that. We want to figure out how to do this in a tax-efficient way. We're completely flexible as to how this can be structured: as a loan, equity stake in the house, outright gift, etc., but the basic idea is:

- They provide the money towards a deposit, with no expectation of capital repayment (it will be deducted from inheritance at a later date, or will form part of the estate's assets, to make it fair for my wife's siblings)

- We give them 3% of the deposit amount each year

Does anyone know where I can go to get some good advice on this? Would my friendly local CPA know about this sort of thing, or do I need a specialist? If I need a specialist, then in what is there specialty, and how do I find one? Do we need lawyers involved?

Any thoughts at all, either on how to do this, or who I need to speak to, would be appreciated.

Thanks!

PC
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We're completely flexible as to how this can be structured: as a loan, equity stake in the house, outright gift, etc.

I would guess an outright gift is likely the best structure - but since there is an explicit expectation that you'll pay them interest, I don't think it's a gift.

Would my friendly local CPA know about this sort of thing
Probably.
I think you have 2 or 3 areas involved here.

1> Income taxes
2> Estate planning ( gift taxes)
3> Estate planning (Inheriting partial RE or the balance of your loan.)
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- They provide the money towards a deposit, with no expectation of capital repayment (it will be deducted from inheritance at a later date, or will form part of the estate's assets, to make it fair for my wife's siblings)

- We give them 3% of the deposit amount each year


What you are describing is a long-term loan. Ideally, you'd document the transaction. A lawyer would be the right professional for that.

You've also got some tax issues. I'd want to check that the 3% interest is sufficient to avoid imputed income. For those calculations, you'd need to talk to a tax professional - an EA, a CPA, or a licensed preparer.

Finally, the lender on the house will be very interested in this transaction. You're essentially taking on another loan - and that may affect your ability to repay the mortgage. Failing to disclose this loan from your in-laws on your mortgage application might be mortgage fraud. You really don't want to go there, particularly in the current lending environment.

--Peter
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Thanks for the advice - I'm going to see if my In-Laws have someone they use for Estate planning, and if so, start from there, and probably get a CPA/EA involved too.

PC
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Here's a suggestion:

You could try Virgin Money (www.virginmoney.com, costs $99, I think) and see if you can structure the "social loan" as a 40- or 50- year "interest only" loan with a balloon payment due at maturity.

Separately, your in-laws could then write their will to forgive the ballon payment (or have a separate "rider" on the promissory note stating that the ballon payment is forgiven upon the death of the last surviving of the in-laws).
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...Oh and definitely get the blessings of an attorney!
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.... I think you have 2 or 3 areas involved here.

1> Income taxes
2> Estate planning ( gift taxes)
3> Estate planning (Inheriting partial RE or the balance of your loan.)...

To expand on the point about income taxes. The loan would need to meet specific criteria for you to be able to deduct the interest as mortgage interest. Your in-laws would need to declare the interest on their taxes and pay income taxes on it. If they are getting social security, then this income could cause more of their social security to be taxable so the effective tax rate on the extra income could be surprisingly high

Also add in;

4> What happens if you get divorced or the inlaws do. I bet if you got divorced and you got the house, then the in-laws still holding the loan would be real fun to deal with.

5> What happens if someone dies and the surviving spouse remarries. It could be a good idea to get some extra life insurance on both you and your spouse to pay off the loan in the event of a death.

6> Almost no one plans on defaulting on a loan. It could happen with the in-laws' loan which could cause family problems.

In looking at this, you should also compare this option to getting the mortgage with less than 20% down and paying PMI. It could be that this doesn't really save you enough to be worth the hassle.

Greg
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I'll tell you how we did it.

We provided $50,000 as downpayment on daughter's first house she paid $200,000 for. We wrote an arm's-length loan agreement with her , using the midterm AFR as the interest rate on an interest only note that would become due and payable when the house was eventually sold. We went on the deed to secure the note, as a 25% holder. This arrangement did not seem to matter to the lender.

She was in the house about 5 years. Each year we gifted her the value of the interest, which did not create a tax issue for her, as she had no other investment income.

We notified our homeowner insurer of our interest on her deed and they noted this on our homeowner's policy, but did not increase our premium.

When the house sold, the escrow company refunded our initial loan amount per our instructions. This was potentially the sticky spot, as the escrow company wanted to initially withhold 20% towards state tax, as this was not our principal residence. But we produced the interest only note and convinced them it was purely a reimbursement.

The other value of this approach is had she not been able to make payments due to illness, death, etc, we could easily step in without having to worry about foreclosure. Of course, we could afford to do this...not sure other parents could.

BruceM
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She was in the house about 5 years. Each year we gifted her the value of the interest, which did not create a tax issue for her, as she had no other investment income.

This statement makes no sense. This was her home, so we're talking about home mortgage interest, not investment interest on her side. On yours, you don't say anything, but I believe you had taxable interest income equal to the forgiven payments. See "Gift Loans" in Pub 550.

Phil
Rule Your Retirement Home Fool
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She was in the house about 5 years. Each year we gifted her the value of the interest, which did not create a tax issue for her, as she had no other investment income.

This statement makes no sense...

It does it you substitue 'tax issue for us' for 'tax issue for her', which is what I meant.

BruceM
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