Loans to Children for Down Payment on House

This is a common scenario: Parents want to help their children with purchasing a new home. Parents agree to give their children the money to put a down payment on a home. But what are the legal and gift tax implications? Who should be the owners on the property? Are there other tax consequences?

As we all know, the only way some children are able to get into the housing market, especially in California, is with help from their parents.  There are easy ways to do that and some more complicated ones. Below are a few options. To understand the options, some background information is needed.

For Federal Estate and Gift Tax purposes, individuals each can give $5.45 million away free from Federal Estate and Gift Taxes during his or her life, at death or any combination of the two.  For example, if an individual gave $1.0 million to each of his or her two children, there would be no actual gift tax, the $1.0 million “taxable gifts” would simply be subtracted from the $5.45 million he or she can give away when he or she dies, leaving $3.45 million available free from Federal Estate Taxes upon his or her death.

“Taxable gifts” are gifts in excess of $14,000 per year per person per donor.  Gifts of under $14,000 per year per person per donor are “exempt.”  That means that the gift of up to $14,000 per year is not subtracted from the $5.45 million lifetime exemption.  So, an individual could give each of his or her children $14,000 per year without chipping away at the $5.45 million each person can give away when he or she dies.

With that background, below is an example with Mom, Dad and two children, Jack and Jill. Let’s assume Jill and Bill (Jill’s husband) want to buy a $600,000 house and need a 30% down payment, or $180,000.

Often, parents pay for the down payment, and then everyone (Jill, Bill, Mom and Dad) takes title as joint tenants. Jill and Bill live in the home, pay the mortgage, and all expenses. The biggest problem with this scenario is liability. Because all of them own the property, if any one of them has a creditor, the house is in jeopardy. If any lawsuit arises as a result of something happening at the house (injury) all four are jointly and severally liable.

Another option is equity sharing, where Mom and Dad have an agreement with Jill and Bill. When Mom and Dad gave the down payment and Jill and Bill agreed to pay the mortgage, property taxes, insurance, maintenance, repairs and utilities, they signed an agreement with Jill and Bill, where Mom and Dad share in the appreciation and equity of the property. The downside is that they have to calculate how to share the appreciation on the property when Jill pays the mortgage, property taxes, insurance, maintenance, repairs and they have to determine who receives the tax write-offs. The question in this complicated scenario is: Do they really want to share in the appreciation and equity of Jill’s home? In most cases, the answer is no.

A third option is to give the $180,000 to Jill. Mom and Dad can each give $14,000 a year to any person. Mom can give Jill $14,000 in one year, and Dad can give Jill $14,000. That means $28,000 is not taxable, but the balance of $152,000 ($76,000 each) are taxable gifts. If Mom and Dad choose to, they can also give $14,000 each to Bill, reducing the taxable gift to $124,000 ($62,000 each). Mom and Dad will have to file a gift tax return.  Of the $10.90 million Mom and Dad can give away free from Federal Estate Taxes, they just reduced that by $152,000 (or by $124,000 if they also make a gift to Bill). We highly recommend that Mom and Dad amend their living trust in this scenario to give Jack an equal gift in that amount ($180,000) if Mom and Dad want to treat the children equally. But, if Bill and Jill later divorce, Bill has an argument that he receives half of the $180,000 in equity.

In the above scenario, if they give the money to Jill, it is subtracted from the $5.45 million that Mom and Dad can give away when they die (less the $14,000 annual exclusion).

A fourth option is a loan. Mom and Dad can loan Jill the down payment. Jill and Bill will sign a fully amortized Promissory Note secured by Deed of Trust against the property that Jill is buying.  The IRS is going to require an interest rate of at least 2.5% on inter-family loans (this rate is subject to change). If the interest rate is 3% on $600,000, the interest is $15,000 per year.  Since Mom and Dad can each give Jill and Bill up to $14,000 per year, the annual interest could be forgiven on December 31st of each year as a gift. Mom and Dad would forgive $28,000 per year of the interest and principal (for Jill’s gifts) and $28,000 per year (for Bill’s gifts if Mom and Dad want to give to their son-in-law). That would be exempt from Federal Gift Tax Rules and the full $5.45 million Exemption for Mom and Dad would remain intact at their deaths, and no gift tax returns would need to be filed.  Again, a subsequent divorce would see Bill leaving with $90,000 of family money.

A final option is to borrow from the Bank of Mom and Dad using an interest only promissory note secured by a Deed of Trust. Mom and Dad can loan Jill the entire $600,000 with an interest only loan at 3%, or $18,000/year. Mom and Dad can forgive the interest each year (see above). It is critical in this scenario for Mom and Dad to amend their living trust to ensure that Jill’s share of the estate includes this loan and that Jack receives an equal amount upon their deaths if their intention is to treat Jack and Jill equally.

Meanwhile, in the last three examples, if Jill and Bill get a divorce, and Bill says he is entitled to one-half (½) of the $600,000 equity in the property, is he?  Not with the interest only note because there is a $600,000 Promissory Note secured by Deed of Trust against the property.  There is no equity to split with the soon-to-be ex-husband. (This scenario is more complicated if Mom and Dad gifted to Bill).

Let’s say Jill and/or Bill get sued for a car accident, a contract issue, a breach of contract issue, etc.  Someone goes after the $600,000 of equity in their home. Is that right?  No, there is no equity because the Promissory Note is secured by a Deed of Trust.

A loan secured by a Deed of Trust would effectively extinguish that debt and also “freeze” Mom’s and Dad’s Estate from any subsequent appreciation on the $600,000 between now and when they die if federal estate taxes are a concern. Since the Federal Estate Tax is forty percent (40%), this is a significant benefit.

On the other hand, if Mom and Dad simply give the money to Jill, Mom and Dad (1) have to file a federal gift tax return (Form 709), informing the IRS that Mom and Dad gifted over $14,000 per person in a year, thus reducing the amount they can give away at death, (2) Jill receives more than Jack if Mom and Dad do not update their estate plan to include that gift as part of Jill’s share of their estate, (3) Mom and Dad receive no estate tax planning benefit or creditor protection as the previous examples provide, and (4) Jill’s equity is subject to claims from Bill if they divorce or creditors if she is sued.


If you find yourself in a similar situation, you should consult an attorney before making any decisions about gifting assets to your children.


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