If you live in Massachusetts you know that the prospect of buying your first home is a daunting one given the high cost of real estate. Parents often want to help their children with their first home purchase by making a gift or a loan to the child to use toward the down payment. For parents (or grandparents) who are in a financial position to do this, it is important that everyone involved understand whether the funds are gift or a loan and the consequences of each. This is also an important Estate Planning question. Read on for factors to think through when providing funds to a child.
If it’s a gift,
- A gift to a person (as opposed to a gift to a charity) is not tax deductible by the person who makes the gift.
- A gift is not income and should not be reported on the recipient’s income tax return.
- For most people, there is no reason to be concerned about gift tax even if the amount of the gift exceeds the annual gift tax exclusion amount of $15,000 (2020) per person per year.
- Even though it is unlikely that there will be any gift tax payable (under current law you would need to gift more than $11.6 million over your lifetime before there would be any gift tax payable) you may be required to file a gift tax return (form 709) reporting the gift.
- You are not entitled to repayment (this may seem as though it goes without saying, but that is not always the case in my experience).
- Making a gift could help your child qualify for a mortgage and you may need to provide a gift letter.
- Making a gift may be advantageous to you from an estate tax perspective as the gifted assets will reduce the value of your estate for estate tax purposes.
- If you have more than one child, consider whether you want to make any changes to your estate plan to ‘even up’ the distribution of your estate among your children to account for the gift to one child.
If it’s a loan,
- It is important to document the loan with a Promissory Note.
- Even if you do not choose to charge interest on the loan, the IRS may think differently and may ‘impute’ taxable interest income to you. Consult with your accountant to make sure you understand the income tax consequences of the loan.
- Interest charged on the loan and paid to you as the lender is taxable income to you in the year received.
- Consider whether the loan should be secured by a mortgage. Even if you are not concerned about repayment, doing so may protect your investment in the event your child gets divorced, is sued, files for bankruptcy, etc.
- Consider what you will do if the loan is not repaid as expected.
- The outstanding balance on the loan will be an asset of your estate and you may want to specify that the Promissory Note should be allocated to the debtor child’s share of your estate.
Seeing a child settled in their first home is a good feeling for parents and helping a child get there is a goal for many parents. However, before you hand over that big check, decide whether you’re making a gift or a loan and make sure your child knows as well.
Attorney Suzanne R. Sayward is a partner with the Dedham firm of Samuel, Sayward & Baler LLC which focuses on advising its clients in the areas of estate planning, estate settlement and elder law matters. She is certified as an Elder Law Attorney by the National Elder Law Foundation, a private organization whose standards for certification are not regulated by the Commonwealth of Massachusetts. This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney. For more information visit www.ssbllc.com or call 781-461-1020.
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