“Our kids are in their twenties, and we’d like to help them buy a home. What’s the best way to start?”
This is a common query among baby boomer parents with a lot of home equity or long-tended stock market investments. If the kids are settled (jobs and such), some mix of co-signing and gifted down payments are an established path.
But it’s not so easy for kids to get settled today. Many are in extended education, working toward a better job. Many adult kids have temporary or contract or limited jobs. In those cases, the parental questions get complicated:
“We think maybe we should buy the place and rent it to them, and give it to them someday. And we could pay cash, but we’re not sure they can really handle being owners. What do you think?”
Good intentions and often big resources there.
I am a mortgage banker — neither a CPA nor an attorney, but I’ve gotten involved in many of these situations over the years, too many times too late, after well-intended families have found themselves in cul-de-sacs. (The worst of the dead ends involve the IRS.)
Buying and renting to kids often runs afoul of the requirement that rent be market rent and the rent included in tax returns. If parents plan to gift a home to their kids, there is no good way to both rent to them and gift the property at the same time.
Keeping control of a big family asset and being slow to transfer the asset to kids are both good ideas, but if transfer is the ultimate intention, construct acquisition with transfer in mind. Co-signing is a good and kind thing to do, but it’s impossible to disentangle the parents without a sale, or a sale to the kids and a refinance by them (the kids) alone.
I frequently talk myself out of loan business this way, but being the banker for your kids is often the best parental route.
Give your kids a loan and let them be the buyers. Yes, it takes a lot of money, but a lot of parents have that kind of money somewhere. They could refinance their home and use the proceeds to finance offspring. Many 60-something parents are sitting on a lot of saved cash earning practically nothing, and reluctant to put more into the stock market — or happy to take a pile out of the stock market.
Parents thinking of buying for cash in the first place should instead become the kids’ 100-percent mortgage lender. Use interest-only terms and the IRS’s minimum interest rates (usually same as Treasury rates, mid-2.00 percent depending on the length of the loan).
If the kids can’t quite swing the payment, make an annual gift which they use to pay parents.
The family gets the best of all worlds: the kids buy the house and have a “cost basis” which helps them ultimately to avoid capital gains taxes. The parents retain control of the asset because of the mortgage lien. If anything goes wrong with the long-term plan, sell the place. And the parents are not entangled in joint liability.
One day the kids will be able to refinance the parents’ loan (always formalize parental financing with a promissory note and recorded mortgage). Or, if deserving and the parents can afford, it is easy to progressively forgive a mortgage (houses change in value, which complicates gifting; a loan balance is a loan balance).
Note to gifting: many parents are confounded by the low annual limit on gifts. Check with your CPA. Under today’s law, each parent has a $5.45 million exemption from estate taxes, which can be reduced to allow a tax-free gift at any time before demise.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
