One of the most common questions we hear from clients is how to help an adult child buy a home. Here we describe the pros and cons of the three most common ways to help your child with a down payment.
Three Ways to Structure the Funds:
Loan The first way to structure the down payment funds is as a loan. The initial down payment amount would be loaned to the child with a set amortization and payment schedule and the remaining traditional bank mortgage would be taken on by the child. The key here is to have a written and agreed upon amortization schedule and follow it. There are also companies that will record a deed of trust or security deed against the property as collateral for the lender’s investment. Generally, unless the mortgage is documented appropriately by a third party, interest payments on the intra-family loan may not be deductible.
The benefits of this approach: This can be a win-win for both the parent and child as the parents will get an income stream and the child will benefit by making reduced mortgage payments while potentially taking advantage of the upside of real estate appreciation, and taking the mortgage interest on the bank mortgage and property tax deductions that owning a home offers. Generally, the IRS interest rates for mid-term intra-family loans are quite low (for example as low as 1.46% for a loan term over 9 years in January 2023), keeping the payments lower than payments on a loan from the bank. The parent could also choose to make an annual exclusion gift of up to $17,000 per spouse per person (so $34,000 per child per couple) that the child could use towards the mortgage payments or any housing expense. Also, when structuring the down payment as a loan, the child keeps any equity appreciation in the home when it is later sold. The costs of this approach: Although still receiving a small interest rate, parents give up greater income and appreciation on the assets lent, which could impact your retirement picture. Assuming the opportunity cost doesn’t have an adverse effect on your financial projection, another downside to this approach is depending on the purchase price of the home and the financial situation of the child: the child might not have the income to support payments on both a mortgage and family loan. Also, if your child will be qualifying for a traditional mortgage in addition to the family loan, the family loan may negatively impact how much they can qualify for from the bank. There are many other important items to consider so be sure to meet with your team, discussed below.
Co-Ownership The funds for the down payment could also be structured as an investment, or an equity purchase in the new home. The initial funds used for the down payment would serve as the parent’s percentage equity ownership, and the balance would be taken on with a mortgage from a bank by the child and would serve as the child’s percentage equity ownership. With this approach, both the parents and the child would be on the title with their respective ownership percentages.
The benefits of this approach: This arrangement could be mutually beneficial as the child doesn’t have to make payments that their income might not be able to support, and the parents get a percentage of the equity appreciation when the home is later sold. The costs of this approach: The child gives up a portion of the equity and appreciation potential by having a co-investor which might inhibit their ability to transfer the equity into a bigger home when they later decide to move. This arrangement might not be great for a married child, as the child’s spouse might not feel comfortable with in-laws being on the title or having an interest in their home. The other downside to this approach is for the parents: although you are still entitled to a portion of the appreciation, your investment is illiquid as your child might not move for many years and without a sale (or a later cash out refinance which may not be possible or beneficial for your child), you will have no access to your principal.
Gift Perhaps the simplest approach is to gift your child the money for the down payment with no strings attached. The child would then take on a mortgage for the remaining amount and the parents would not have any equity or debt interest in the home. Firstly, you’d want to be certain you are in the position to be able to make a gift without receiving anything back before doing so. Also, until recently, the gift and estate tax exemption (the amount passable to your heirs free of Federal estate tax) was $5M per person, an amount that was considered relatively high, but still low enough to plan before using any of it (such as by making a taxable gift of more than $17,000 per person annually in 2023). With the passage of the Tax Cuts and Jobs Act of 2017, the gift and estate tax exemption is now $12.92M per person (2023), so depending on your overall net worth and previous estate planning moves made, making a gift outright or in trust is an option.
The benefits of this approach: The key benefits here are its simplicity and the financial benefits to your child not requiring interest or principal payments, or later, any splitting of profits from a home sale. It also likely keeps the property owned solely by your child, or your child and his/her spouse, which they likely prefer. The costs of this approach: The greatest cost of this approach is the amount given without receiving anything in return. But assuming your gift doesn’t impact your financial projections, another cost is the estate exemption you are using. You will be required to file a Gift Tax Return to report the gift to the IRS if the gift is more than $34,000 from parents, or $17,000 from one parent. There shouldn’t be any actual gift tax due, but the gift will reduce your available estate and gift tax exemption amount. Generally, we would say gifting is the last option on the list in order to preserve your estate exemption to the extent possible. Before making a gift, we suggest working with your financial planner to run a few projections to determine whether you are likely to have an estate over the exemption amount. If you determine you are likely to have an estate over the exemption amount, consider utilizing options 1 or 2 before this option.
Make sure you can afford to help. We understand the desire to help, but remember that your child has more time on their side to save. Before committing to loaning or gifting anything, be sure to check with your financial planner to ensure it won’t negatively impact your retirement picture.
Who will take the mortgage interest and property tax deduction? The answer depends primarily on who is paying them. Most CPAs agree that regardless of who is on the title or whose name is on the mortgage, the person paying these expenses takes the deduction. In most cases, the child will be paying them, so they would likely get the deduction. Be sure to confirm with your CPA and explain your specific situation.
Many parents are concerned with equalization of gifts or loans between children. This can be a challenge as often, when one child is ready and able to buy a home, the other child(ren) may not be in the same position. There are several ways to create an equalizing asset transfer, mostly through updates to your estate plan. Speak with your estate attorney about ways to structure your wishes.
Consider spouses. If your child is married, there is another level of planning you might want to consider. Again, be sure to work with your estate attorney to create your plan according to your wishes, but most parents prefer the loaned or gifted amount stay in the family bloodline. It might require establishing an irrevocable trust for your child or a separate living trust for just your child to take the down payment and/or title to the home.
Consider how to title the property. It is worth the small cost of an attorney’s time to ensure proper titling as it is important to ensure that the asset passes as intended. Often, the home should be owned by a trust, or a combination of trusts. It’s often recommended your child create an estate plan including a living trust, or potentially a separate property trust, to own the home. If the home is co-owned, it could be held by the parent’s living trust and the child’s living or irrevocable trust. If the home is to be owned solely by your child, in the case of a loan or a gift, it should likely be held by your child’s living or irrevocable trust. Also, as the parent/lender, be sure to ask your estate attorney if updates to your trust are needed to include a provision that the note receivable or investment in your child’s property be offset against other assets so their sibling doesn’t unintentionally end up with an interest in their sibling’s home.
Meet with your team. A great gifting plan involves many moving parts including projecting your lifetime cash flow needs, analyzing what you paid for the assets you might bestow or sell, and evaluating the most appropriate tax moves and how to title assets. We suggest that parents and grandparents consult their financial planner, estate attorney, and tax professional to make sure that loans, joint ventures, and gifts to a child are affordable and executed to provide optimum value.
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