no interest loan

[bgiez]

TP buys condo for daughter so daughter can live closer to work. Per TP, loan is set up as a land contract, no interest, where daughter will pay TP back when daughter's old home is sold. Condo stays in TP's name until daughter repays. Since there is not a specified payment schedule, does this make it a demand loan?

Cost of condo including closing costs 134K, so doesn't fall under $100,000 exception. Per TP, her attorney drew up the land contract, which clearly states (per TP - I have not seen the agreement) that the purchase price is not a gift and is meant to be repaid.

Thanks for any help.

Barbara, E.A.

[Edsel]

Loan must be discounted

IRS does not quibble with whether interest is charged for legal purposes.

So long as it becomes effective for TAX purposes. I think she's OK for a year, but then after that must "impute" interest. I believe IRS has specified a rate in some publication, maybe T-bills, as a minimum. And of course, the rate changes from time to time.

[Davc]

When imputed interest is required the rate is set at the time the loan is made. It's not variable once set.

[Gary2]

In the absence of a payment schedule, why does the loan even exist? Did the TP want some sort of guarantee from the daughter that she would buy the condo eventually? Presumably it's too late to change things, but:

Without the loan, it's a second (or third or fourth) home, in which the TP is allowing her daughter to live. I'd expect that to be, at worst, a gift of rental at FMV. With a purchase price of $134K, and assuming daughter provides the furniture and pays the utilities, I'd expect the FMV as a rental to be below the gift tax filing requirements.

Wouldn't this have been a simpler approach?

[Burke]

I would get a copy of that contract. How can there be a " land contract " unless he sold the home to her? He would retain a deed of trust for the note, which from what you state would be a demand note. Did he purchase for cash or get a mortgage?

[bgiez]

Clients seem to shoot first and ask questions later

Burke -TP purchased for cash, so she has no mortgage. The land contract was drawn up by an attorney and the title doesn't pass until the daughter pays in full. The sale of the daughter's old home will generate enough cash, apparently, to pay her mother back.

Gary2 - The TP has 5 other adult children and doesn't have enough of an estate to leave $134K to each, and you know how parents like to treat all of their children the same. And there is a loan - that's what the land contract is about. The daughter furnished the condo and is paying the costs of occupancy - utilities, association fees, etc. And yes, it may have been simpler to not draw up the land contract and just sell the home to the daughter when the daughter's old home sold, but the TP is quite elderly, and as she told, me, "I could die tomorrow."

Davc - I was trying to figure out if this would be considered a demand loan, because from what I have read (from a link provided in an older thread), a demand loan has less stringent imputed interest requirements.

So, I guess my main question is whether this should be treated as a demand loan, or, should it be looked at as a gift of fair market rental, or is there some other way to look at this so there is less of a tax implication for my client.

Thanks for the input. Any other thoughts?

Barbara, E.A.

[Burke]

It is not a gift. There is a legal note with a payment requirement, and this fact (no gift) is even stated in the contract. Appears to be an installment sale with a mortgage loan since payment is delayed on a contingency. If the parent dies, the child owes the money to the estate unless it has been paid back. Daughter may not get a clear title until paid off. I am thinking imputed interest rules will apply unless TP wishes to make annual gift exclusions of forgiveness of the debt.

[Davc]

I am thinking imputed interest rules will apply unless TP wishes to make annual gift exclusions of forgiveness of the debt.

They would still apply but the TP could gift the interest. However it would still be income to her.

[Burke]

I agree with that.

[jimenright]

see TTB pg 21-24

"below market gift loan" the foregone interest is a gift from the lender subject to gift tax. If the borrower's net investment income is more than $1000 there is taxable interest income to the lender limited to the borrower's net investment income. The loan cannot be for tax avoidance purposes.

[jimenright]

see TTB pg 21-24

"below market gift loan" the foregone interest is a gift from the lender subject to gift tax. If the borrower's net investment income is more than $1000 there is taxable income to the lender limited to the borrower's net investment income. The loan cannot be for tax avoidance purposes.

[Gary2]

Just to be clear, I wasn't commenting on whether the current situation is or is not a gift. I was just asking if they wouldn't have been better off if they had gone another route. This was answered by response that there were other children so the parent didn't want to appear to be favoring one child.

I agree that in the current situation as is, they are at least trying to structure it to avoid any gift.

[bgiez]

no interest loan update

Just in case you wanted to know....

Turns out that this is considered a gift term loan, and gift term loans are automatically treated as demand loans regardless of the structure of the payments. Foregone interest is computed as though it were a demand loan except the Applicable Federal Rate is based on the term of the loan and semi-annual compounding in effect on the day the loan is made instead of the rate in effect during the period the foregone interest is computed.

So, since the loan is dated 11/30/10 and must be repaid before 20 years is up, my client will have to report the imputed/foregone interest for the one month in 2010, then annually thereafter for the foregone interest computed each year.

And I get to do a gift tax return each year that there is a balance owing. The client will be claiming imputed interest each year that there is a balance during the year.

Next year, assuming the daughter's house sold and she has begun making payments, my question will be - In order to compute the interest, do I take the average balance outstanding in each semi-annual period, or the outstanding balance as of a certain date? In the words of Scarlett O'Hara, "I can't think about that right now. If I do, I'll go crazy. I'll think about that tomorrow."

[bgiez]

Here's the latest

Client calls the other day and says her daughter checked TurboTax and told her (my client) that she doesn't have to report any (imputed) interest for 2010 because she (the daughter) hasn't paid anything yet.

In the meantime I'm still working through the 14 pages of information I received from NATP on this issue, so I tell my client that I am still working through it, but it appears that she does indeed need to claim the imputed interest for 2010, even though she has not had a payment from the daughter yet.

So then I call the client when I have it figured out and tell her that she will have $372 of imputed interest on her 2010 return and will have approximately $4600 or less, depending on when her daughter starts making payments, on her 2011 return. "Well," she says, "if I have to report it, I might as well actually receive it. I'm going to call my attorney and make a new contract with interest."

Client calls this morning and said she spoke to her attorney, you know, the one who wrote up the contract between my client and her daughter and never told her to check with her tax professional to see what tax impact such a contract might have. So she says the attorney tells her to just have me prepare a gift tax return for the whole loan amount and there will be no imputed interest. So I said, Oh, so you are voiding the contract and GIVING the condo to your daughter and she is not paying you anything? So now my client wants me to talk to her attorney, so I asked her to send me a letter authorizing me to talk to him about this in relation to her tax return.

Argh!

[luke]

good grief

what a mess! who is worse the client/ the client's kid or the FR$%#^&@ attorney!
make sure to get PAID for your trouble cause this one will most definitely be around to "haunt" you for a long time.......