How to Structure Gift Dollars for (future) Home buyers!

by Mario Acosta on April 21, 2015

in Buyers, First-Time Home Buyers

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It is common for many buyers to receive gift funds from a family member(s). All of which begs the question how to avoid the dreaded Gift Tax. How that gift is structured can be a sensitive family issue. In order to avoid paying that tax…it’s important to structure the transaction properly BOTH ON  A PERSONAL LEVEL AND TRANSACTIONAL LEVEL. Family baggage, sibling rivalries, legal and tax consequences MAY need to be addressed between the giver and receiver far in advance, before the buyer begins searching for a property.

In 2014 the annual limit for (exclusionary) gift income is $14K per giverper recipient  (“gift splitting”).

Example: Harold and Helen Smith (husband and wife) agree to split gift funds of $26K during 2012.

Harold gives his son George, $13K, and Helen gives George’s wife (daughter in law) Gina, $13K. Each gift is equal to the annual exclusion ($13,000) by gift splitting they can make these gifts without making a taxable gift. Any additional monies over the $26k the Smiths wish to give, can be secured by a junior lien (i.e. 2nd T.D.) as a way to protect a parent’s gift interest on behalf of their child.

For example: the Smith’s son may have married a young woman of questionable (in their eyes) long term “economic viability” and “spousal capacity”.

In that case: The Smiths (who desperately want their grandchildren to grow up in a stable home environment) feel uncomfortable just handing over additional monies (because of community property laws).

So to protect their interests they require the young couple to sign a 2nd Trust deed with themselves as the beneficiary at close of escrow. This gives the “grandparents” some additional leverage in the event a divorce occurs, a child custody case erupts or the 1st Trust Deed teeters on verge of foreclosure. Any family member can structure the gift as a loan and charge zero interest, but may face unfavorable and complicated tax rules. But tax-law complications can be avoided by charging an interest rate that at least equals the applicable federal rate (AFR) approved by the Internal Revenue Service. Current AFRs for term loans—meaning loans with a defined repayment schedule or a specific balloon-payment due date—are as follows (based on semiannual compounding):

A) 0.23% for “short-term” loans of up to three years.

B) 1.07% for “mid-term” loans over three years but not over nine years.

C) 2.61% for “long-term” loans over nine years.

AFRs are updated monthly in response to ever-changing bond-market conditions. AFRs for each month are published in the Internal Revenue Bulletin (found at www.irs.gov).

The AFR rate is determined by the month when the loan is funded. The “giver” (now the “lender”) must declare the interest payments received as income on their tax returns (Form 1040). The “recipient” (now the borrower) can deduct the interest payments: provided it’s a secured by a home (via a 2nd trust deed). If the loan has a “demand feature” (as opposed to a specific “term”), the AFR isn’t fixed in the month the loan funds. Instead, the AFR is floating and based on the changing short-term AFR rates. If the giver/lender makes an “interest-free loan” (“straight note”) the dreaded below-market interest rules may apply. If so, the giver AND lender MUST follow complicated rules to calculate imaginary interest payments. In order to avoid this issue both parties must put the loan in writing. Several online services, such as nolo.com, offer low-cost, do-it-yourself loan documents.

 Lastly:

Whenever possible it’s best the gift $$$ be deposited into the recipient’s account…well before the transaction has been initiated.

Here’s why:

1)   Any credit issues (low scores and debt negotiation / reduction resolution) can be dealt with in advance with those funds.

(A downside is: the “loving young couple” may decide to blow all part of the $$$ on something besides the home purchase).

2)  Simplicity: No actual gift letter forms need to be completed or paper trail of $$$ need to be provided.

3)   When an underwriter reviews a loan application, the U/W is judging the overall viability and strength of a borrower.

For example: If the buyer/borrower has a high “Debt to Income” ratio (DTI) or marginal credit scores (under 640), the borrower will appear stronger IF the funds have been “seasoned”.

In order to “season” gift $$$ , the funds must be in the recipients  account for typically 61 days or as long as 89 days depending on the cycle date of the bank statement.

Please contact real estate agent Mario Acosta if you have any questions on real estate or  how to structure your gift dollars for your future home buyers.

 

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Post by Mario Acosta

Mario has written 59 articles.

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