First National Bank of Mom and Dad
Squeezed by high prices, young buyers are turning to relatives for help. Do it right and you'll limit any tax hits--and any family friction.
(MONEY Magazine) – When Tammy Crystal, 25, bought her first place two years ago, she got some unexpected help. Her grandparents, Pat and John Carter, announced that they were giving her $22,000 for a down payment on the Overland Park, Kans. ranch house. "We had the money, and we wanted to help," explains Pat. Now Crystal is trading up. Thanks to an additional $100,000 gift from the Carters, she's buying a $225,000 two-story house. Says Crystal, a high school diving coach: "When my grandparents told me they wanted to finance this, I started crying. I couldn't believe it."
It's only natural to want to ride to the rescue when a child or grandchild can't quite afford that starter house. After all, what could be better than seeing the kids settled in a home and building their own wealth? "Many parents wait until they die to gift to their children," says Ryan Fleming, a financial planner in Washington, D.C. "But when you can see the result of your gifts during your lifetime, it's such a joy."
As for the potential recipients of your largesse, whatever stigma was attached to accepting parental help seems to be on the wane: The National Association of Realtors reports that 24% of first-time buyers in 2004 received gifts for a down payment from friends or relatives (usually parents), compared with 18% in 1991.
That's partly the result of soaring real estate prices; sometimes a boost from Mom and Dad is the only way for a young family to own the roof over their heads. But it's also true that more and more parents and grandparents simply have the wherewithal to help. "The baby boomers have acquired more wealth than any previous generation," notes Jim Gillespie, president and CEO of Coldwell Banker Real Estate. "Now their children are moving into adulthood, and they're looking to their parents for help in buying a home. And they're getting it."
However tempting it is to be a hero to the kids, though, you do need to think your actions through. There are wrong ways to go about this, and they can leave you with financial headaches and family heartache that you could regret for years. So before you even consider the ways to help, memorize these guidelines.
» YOUR OWN SECURITY COMES FIRST "I've seen clients who were just about ready to retire, but lo and behold their children were asking for money for down payments," says financial planner Bob Mecca of Mount Prospect, Ill. "Now they are pushing back retirement." That price may seem worth it to you to help your children. But it's crucial not to sacrifice too much of your retirement nest egg in doing so--or you might someday face the horrifying prospect of selling your own house and moving in with your kids.
» DON'T CONFUSE GIVING WITH INVESTING Remember, home ownership is not a guaranteed ticket to wealth. Housing prices can tumble in even the mightiest markets. And at today's prices, most real estate experts expect future appreciation to slow. Give your kids or grandkids financial assistance because they need a place to live and you can afford to help--not because you want a juicy return on your money.
» SOMETIMES IT'S BETTER NOT TO GIVE Ask yourself whether your children are prepared to be truly independent, or if they continually count on you for money. "Parents know whether their kids are financially responsible or not," says David Diesslin, a financial planner in Fort Worth. "If the child is not responsible, then it's better to just say no, even though it's hard to do." Instead, let your kids learn discipline first by saving and investing on their own.
Ready to write a check? Your next step is to choose the right strategy for lending a hand. Here are the options.
Option 1: Let them live at home and save big-time. Probably the most common way that parents help out these days is by having their adult children live at home until they've accumulated enough to buy a house. That strategy worked well for Winston and Flo Francisco, who invited their daughter Ella and her family to live with them in pricey San Jose, one of the most overheated real estate markets in the country (see the box below). Just make sure you don't lay the groundwork for a clash of expectations: Spell out rules for paying rent and sharing household duties, and set a target date for when your child is expected to move out.
Option 2: Help them with the down payment. This can be the most effective way to make a difference, as the Carters decided. It's a double benefit to the child: Each dollar you provide is one less your kids must produce from their meager savings, and it's one less they have to borrow and pay interest on over the years.
Just be careful to observe the tax laws. Internal Revenue Service rules allow you to give cash or property worth as much as $11,000 a year per recipient tax-free--$22,000 if you give jointly with your spouse and $44,000 if you both give to your child and his or her spouse. (The Carters jointly gave $22,000 to granddaughter Crystal for her first house, and another $18,000 to her parents, who then decided to give their share to Crystal too. That's okay under tax rules, accountants say, as long as there was no formal agreement or requirement for the parents to pass the money on to someone else.)
Amounts above the annual limit are subject to gift tax, but odds are you'll never have to pay it. That's because, in addition to the $11,000 annual gift exemption, you also get a $1 million lifetime exemption. So if you exceed the $11,000 annual cutoff, you just fill out an IRS form and count the excess against the $1 million lifetime limit. Your estate is taxed only if the sum of your annual excess gifts has surpassed $1 million.
Don't want to mess with the gift tax? Lend the money instead. To avoid problems in the event of an IRS audit--and to satisfy some lenders--you'll need to put the loan agreement in writing. (You can get a loan form at an office-supply store or work with an attorney if you wish.) You must also charge an interest rate reasonably close to what commercial lenders levy for such loans. Your child can deduct the interest he or she pays you--and you will owe tax on it. Another approach, says Bob Doyle, an accountant and adviser in St. Petersburg, is to combine giving and lending: Lend the money, then forgive as much as $11,000 of the loan each year.
Option 3: Cosign a mortgage. If your kid doesn't qualify for a mortgage (maybe his income is too low or her credit record too poor), consider cosigning--but only if you're prepared to pay off the whole thing. After all, you'll be on the hook for the mortgage if your child can't make the payments. Cosigning may also crimp your ability to take on more debt for things like buying a second home or a new car. And be aware: Any appreciation in the house belongs to the child, not you. Still, cosigning has worked wonders for many folks, such as Heather and Bob Kerin, who bought the house Heather grew up in from her parents (see the box).
Option 4: Buy their house. "These days I'm seeing more and more clients buying homes outright for their kids," says real estate agent Kathie Welch of Birmingham, where prices spiked as much as 20% last year. "They want to make sure their children are not priced out of good neighborhoods and their grandchildren can go to the best schools."
Buying the kid a home means one heck of a deduction from your $1 million life-time gift credit. Some folks opt instead for co-ownership, which means putting the name of the parent on the deed along with the child's. That way, you're entitled to a share of any gains as well as being responsible for the mortgage payments.
Warning: Co-ownership can lead to family conflicts. How will you share in the house's appreciation? What happens if one of you wants to sell and the other doesn't? "You can run into some ugly situations," warns Doyle. "It's important to spell out the terms in advance." So talk to a lawyer or an accountant before you sign. You don't want that Waltons moment turning into something from The Sopranos.