Tax consequences of family loan?


A

AES

Divorcing son needs immediate financial assistance (over and
above mortgage loan he can obtain) to buy out
daughter-in-law's share of their family residence.

Retired parents propose to get amount of cash needed by son
from a home equity line of credit on their primary
residence, or on second residence/vacation home (both of
these currently fully paid for, and they do reside in each
part of the year), and loan it to son as an effectively
interest-only note.

Son then will then pay parents on this internal family loan;
parents will pay interest on the home equity loan.
Assumption is that principal will ultimately be recovered
either by gradual voluntary repayments from son, or from
son's share of expected inheritance at parents' second
death.

Question is how to determine monthly amount son should pay
parents monthly so that it will all be legal tax wise, and
the deal will be net a wash for the parents

Further consideration are that parents are in max tax
bracket at the margin on their joint return but are not yet
hit by AMT, and they will presumably (?) be able to take
itemized tax deduction for their interest payments on the
HEL, as they have in the past when they used money from it
for other purposes. Son presumably can not deduct his
interest payments to parents; these payments may or may not
(???) be taxable income to parents.

Any tax counsel on this? Or alternative ways to structure
it?

If they do this

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J

joetaxpayer

AES said:
Retired parents propose to get amount of cash needed by son
from a home equity line of credit on their primary
residence, or on second residence/vacation home (both of
these currently fully paid for, and they do reside in each
part of the year), and loan it to son as an effectively
interest-only note.

Question is how to determine monthly amount son should pay
parents monthly so that it will all be legal tax wise, and
the deal will be net a wash for the parents

Further consideration are that parents are in max tax
bracket at the margin on their joint return but are not yet
hit by AMT, and they will presumably (?) be able to take
itemized tax deduction for their interest payments on the
HEL, as they have in the past when they used money from it
for other purposes. Son presumably can not deduct his
interest payments to parents; these payments may or may not
(???) be taxable income to parents.
If the parents make the loan legit, i.e. have a written
contract in place and place a second lien on the son's
property, the interest the son pays is a deduction to him,
and would net out to the parents. Why would you presume the
son cannot deduct legitimate interest payments? The rate
should be a reasonable market rate, there are IRS docs that
should indicate a minimum rate. Even then the parents can
gift the son $24,000/yr to help him out.

JOE

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 
S

Seth

AES said:
Divorcing son needs immediate financial assistance (over and
above mortgage loan he can obtain) to buy out
daughter-in-law's share of their family residence.

Son presumably can not deduct his
interest payments to parents;
Why not? It's mortgage payments.
these payments may or may not
(???) be taxable income to parents.
They are taxable to parents; if the rate is the same as the
parents pay on their loan, it's a wash.

Seth

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 
S

sumarongiamai

AES said:
{ Divorcing son needs financial assistance (above
mortgage loan he can obtain) to buy out divorcing
wife's share of their marital residence by borrowing
the amount in question from his parents after they
generate the cash from a home equity loan on one of
their owned outright primary or vacation residences
and he proposes to memorialze the loan to him by
giving them an effectively interest-only note the
principal of which, maybe, he would repay eventually
in gradual voluntary repayments or by deducting the
unpaid balance from his expected otherwise payable
share of his inheritance after the death of the second
to die of his parents. }
One easily can understand what an "interest only" loan would
be, but what do you mean by "effectively interest-only"?
And what have they agreed shall be his "gradual voluntary
repayment"? Is he going to repay the loan, or not? And if
their understanding is that he will pay only "voluntarily"
and "gradually" (whatever you think you mean by those words
if you are not referring to a contractually defined
repayment schedule), how/why would he and they expect if
they eventually are called upon to explain (e.g., by the
IRS) that the sum not paid to be anything other than a gift
(the "looking like a duck, having feathers like a duck,
quacking like a duck" problem)? Will the presumed "savings"
to the son by whatever you have in mind actually justify the
hassles if the parents, or the survivor of them or the son
does encounter a need to justify the, "It's a genuine
'loan'!" claim to federal or state taxing authorities?
{ The parents intend to deduct the interest they will
be paying on their HEL and the son presumes he may
not deduct his interest payments to his parents. }
If the son wants to be able lawfully to deduct his interest
payments, why doesn't he just give his parents a mortgage
which they would record?
these payments may or may not be taxable
income to parents.
On what basis do the parents and son evidently believe that
this income to the parents -- the amounts the son will be
paying them as interest -- are anything other than ordinary
(reportable/taxable) income to the parents (if he/they
really do want to want "it [to be] all legal tax wise")?
{ parents are in max tax bracket at the margin but
not yet hit by AMT, and would like to keep matters
that way. How should they determine the monthly
amount of interest the son should pay to achieve this
end and also to achieve a net cost-free "wash" for
the parents? }
One obvious way is simply to retreat from their so far
unsupported apparent assumption that the son's interest
payments will not be reportable taxable income to the
parents then to make presumably relatively simple pro forma
calculations to achieve these ends then just prepare the
son's note's payment schedule accordingly.

Maybe more basically, if, as you seem to suggest, the
parents are credit-worthy, why does not the son revisit his
assumption that he (alone) would not be able to obtain a
mortgage by all of them adopting the KISS principle by the
son applying for a conventional mortgage on his about to be
solely-owned home but with the credit worthy parents as
guarantors of payment thereof?
Or alternative ways to structure it?
Very likely, yes - but which of any number of alternatives
to use would depend on knowing the details of the parents'
and son's expected income and the parents' actually intended
estate disposition and estate tax plan insofar as the latter
is reasonably estimatable.

And re. that estate plan issue, will the parents be making
yearly gifts of the allowable maximum amount to an
individual to reduce the sum otherwise due if he will have
agreed to some amount due? Does it make good estate tax
planning (insofar as one can/cannot predict what will happen
to federal estate tax rates if they live beyond the
expiration of the present schedule therefor) and, in any
event, aren't you really suggesting that it is these sorts
of issues, not the details of the
bank(HEL)-loan-to-parents/parents-"loan"-to-son transactions
that actually most concern (or, in any event, should
concern) the parties?

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 
A

AES

joetaxpayer said:
If the parents make the loan legit, i.e. have a written
contract in place and place a second lien on the son's
property, the interest the son pays is a deduction to him,
and would net out to the parents. Why would you presume the
son cannot deduct legitimate interest payments?
Because I was supposing that the parents would just make a
"family loan" to the son, documented by some simple written
note or instrument, but no more than that.

I hadn't thought about the parents actually taking some kind
of second lien on the son's property, so that the money he
borrows is actually secured by an encumbrance on his
residence (which then makes his interest payments to the
parents deductible to him, if I understand what you're
saying).

Is a "second lien" essentially the same as a "second
mortgage"?

And can the parents in essence go into the business of
marketing second mortgages (even if it's only one such
mortgage, to their own son) without running into all sorts
of legal requirements for having a business license and the
like?

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 
E

eagent

AES said:
Divorcing son needs immediate financial assistance (over and
above mortgage loan he can obtain) to buy out
daughter-in-law's share of their family residence.

Retired parents propose to get amount of cash needed by son
from a home equity line of credit on their primary
residence, or on second residence/vacation home (both of
these currently fully paid for, and they do reside in each
part of the year), and loan it to son as an effectively
interest-only note.

Son then will then pay parents on this internal family loan;
parents will pay interest on the home equity loan.
Assumption is that principal will ultimately be recovered
either by gradual voluntary repayments from son, or from
son's share of expected inheritance at parents' second
death.

Question is how to determine monthly amount son should pay
parents monthly so that it will all be legal tax wise, and
the deal will be net a wash for the parents

Further consideration are that parents are in max tax
bracket at the margin on their joint return but are not yet
hit by AMT, and they will presumably (?) be able to take
itemized tax deduction for their interest payments on the
HEL, as they have in the past when they used money from it
for other purposes. Son presumably can not deduct his
interest payments to parents; these payments may or may not
(???) be taxable income to parents.

Any tax counsel on this? Or alternative ways to structure
it?

If they do this
You have several issues here, that I'll try to address
separately:

1 - his parents CAN loan him any amount they wish as long as
the loan is documented;

2 - IF they secure the loan with the house then it will be
considered a mortgage and the son CAN deduct the interest
payments to his parents;

3 - The parents WILL have taxable income from the receipt of
the interest payments - REGARDLESS of whether the home is
secured or not. However, this will be close to a wash - they
will report interest income on Schedule B and Investment
Interest Expense on Form 4952;

4 - Parents could elect to claim the interest they pay as
deductible mortgage interest ONLY on the first $100K of the
loan they take out (you didn't mention the loan amount). If
the parents borrow more than $100K to loan the son they
cannot deduct the interest on the amount over $100K as
mortgage interest on their return;

5 - if the parents DO deduct the mortgage they pay as
mortgage interest on their return it IS an adjustment item
for calculating AMT - this could very well push them into an
AMT situation;

6 - loan from parents to son CAN be interest only with son
making nonstructured principal reduction payments on the
loan, but the loan document MUST be drafted correctly and
should include a balloon provision - maybe 30 years hence?;

What you didn't ask, but I'll offer - WHY must the son keep
this house and why can't he get the mortgage necessary to
keep it?

If the house isn't worth enough (read that won't appraise)
to justify the mortgage then why would he buy a house that
costs more than its worth?

If he hasn't the creditworthyness to obtain a loan for more
the parents should look to why they bank won't lend him the
money. If it because he doesn't have enough income to cover
the payments then they need to be very careful. They can
loan him the money but if he misses payments and they don't
attempt to enforce collection the loan could easily be
recharachterized as a gift which would trigger a gift tax
return. Likely no tax would be due but an information
return would be.

The also need to be careful about this because if it gets
reclassified as a gift they can no longer claim the interest
paid as investment interest expense on Form 4952 and THIS
would almost certainly trigger the AMT for them.

Lastly, and this is the one that most of us don't like to
hear - maybe its time for the son to stand on his own. The
parents need to take a close hard look at their own
situation. I have several clients right now that are in
financial difficulty because they tried to help out needy
kids who had a poor track record of being responsible. It
came as no surprise to anyone but them when their kids
defaulted on the money they borrowed to help the kids out
and the parents in at least one situation don't have the
cash resources to repay the loan that they cosigned and are
now on the hook for. The parents may actually have to sell
their vacation home to cover JRs debt.

Good luck,
Gene E. Utterback, EA, RFC, ABA
 
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J

joetaxpayer

AES said:
I hadn't thought about the parents actually taking some kind
of second lien on the son's property, so that the money he
borrows is actually secured by an encumbrance on his
residence (which then makes his interest payments to the
parents deductible to him, if I understand what you're
saying).
you got it right. Going through that slight expense and
effort makes the loan legit, taxwise.
Is a "second lien" essentially the same as a "second
mortgage"?
well, a mortgage is a loan, a lien is an encumbrance on
property, a mortgage without a lien is like a pit bull with
no teeth. something like that.
And can the parents in essence go into the business of
marketing second mortgages (even if it's only one such
mortgage, to their own son) without running into all sorts
of legal requirements for having a business license and the
like?
I don't know what level of lending requires a license, I do
know loans of this type to family members do not.

JOE

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 
S

Seth

eagent said:
If he hasn't the creditworthyness to obtain a loan for more
the parents should look to why they bank won't lend him the
money. If it because he doesn't have enough income to cover
the payments then they need to be very careful. They can
loan him the money but if he misses payments and they don't
attempt to enforce collection the loan could easily be
recharachterized as a gift which would trigger a gift tax
return. Likely no tax would be due but an information
return would be.
If he misses a payment, they can characterize the amount of
*that payment* as a gift; up to $24,000 per year is no
problem.

Or, they can make it a second loan (add it to the remaining
principle).

Seth

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 
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S

Stuart Bronstein

If he misses a payment, they can characterize the amount of
*that payment* as a gift; up to $24,000 per year is no
problem.

Or, they can make it a second loan (add it to the remaining
principle).
You have to be careful when doing that. When a missed
payment (that's required to include interest) is turned into
a gift, one of the parties will have to recognize the
imputed interest. Either the child can recognize it as
cancellation of debt income, or the parent can recognize it
as taxable income they had the option to receive.

Stu

<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>
 

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