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Posted by eagent on September 24, 2007, 8:48 pm
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> 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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